USD EUR Exchange Rate Struggles to Find Support Ahead of Fed Policy Statement

July 25, 2017 - Written by David Woodsmith

STORY LINK USD EUR Exchange Rate Struggles to Find Support Ahead of Fed Policy Statement

As the German IFO business sentiment survey proved stronger than anticipated the US Dollar Euro exchange rate remained on a weaker footing.

Investors were encouraged to find that optimism within the Eurozone’s powerhouse economy had picked up in July, in defiance of forecasts.

This boosted hopes that the German economy will continue to gain momentum in the coming months, potentially increasing the pressure on European Central Bank (ECB) policymakers to consider a shift towards greater hawkishness.

As Carsten Brzeski, Chief Economist at ING, noted:

‘It currently seems as if really nothing can stop the German recovery. Unless German businesses are living in a kind of never-never land, today’s IFO index is a clear signal that the German economy is powering ahead.

‘The current acceleration in the German economy is not only the result of strong private and public consumption, but also of an unexpected industrial revival and stronger investment. Almost unnoticed, the industry has gone from being sluggish to buoyant.’

Even so, the ECB looks set to maintain its current neutral bias on interest rates in the near term, with interest rates likely to remain at their record lows for some time to come.

Euro Forecast to Soften on Weaker German Inflation Rate

Confidence in the single currency could diminish sharply ahead of the weekend if the latest German consumer price index fails to encourage investors.

Forecasts point towards a slight slowing in inflationary pressure on the year in July, with the monthly measure expected to hold steady at 0.2%.

An upside surprise here could offer the Euro a fresh rally, with stronger German inflation likely to encourage bets that the ECB will start to taper its quantitative easing program sooner rather than later.

On the other hand, if inflation slows on the month this could encourage the USD EUR exchange rate to recover ground, further diminishing the prospect of a hawkish ECB outlook.

With concerns over the future of Greece fading in the wake of the Hellenic Republic’s return to the bond market, though, the underlying trend of the Euro is likely to remain largely bullish.

US Dollar Volatility in Store on Fed Rate Decision

Demand for the US Dollar, meanwhile, looks set to remain relatively muted in anticipation of Wednesday’s Federal Open Market Committee (FOMC) rate decision.

While markets do not anticipate any material change in monetary policy at this juncture the meeting is still likely to garner significant interest, with the potential to generate fresh ‘Greenback’ volatility.

If the accompanying Fed statement indicates that policymakers remain committed to raising interest rates again before the end of the year this could set the USD EUR exchange rate on a strong uptrend.

However, any references to discontent regarding the domestic inflationary outlook could weigh heavily on the appeal of the US Dollar.

As Mikael Olai Milhøj, Senior Analyst at Danske Bank, noted:

‘Due to the Fed’s strong belief in the Phillips curve and given we expect further tightening of the labour market, we think the Fed will hike one more time this year in December. We still think risks are skewed towards the Fed pausing its hiking cycle due to low inflation, which may not be just ‘transitory’ given the low inflation expectations.’

Downside pressure on the US Dollar is likely to mount on the back of July’s US consumer confidence index, which is expected to show an easing in domestic sentiment.

If the index falls from 118.9 to 116 as forecast this could prompt the USD EUR exchange rate to extend its losses this afternoon.

While investors are still largely sceptical over the prospect of the Trump administration delivering on its promised infrastructure investment and tax reforms political jitters have nevertheless eased since the start of the week.

Any further signs of weakness within the world’s largest economy could hamper USD strength, particularly if the wider sense of market risk appetite weakens in the coming days.

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TAGS: Euro Forecasts