Euro Forecast at Risk Ahead of European Central Bank Rate Decision

Written by David Rodriguez, Quantitative Analyst

Euro Forecast at Risk Ahead of European Central Bank Rate Decision

Fundamental Outlook for Euro This Week: Bearish

- Dismal German GDP data sends euro to bottom of trading range
- German IFO economic sentiment falls to fresh record low
- Forex trading markets next look to European Central Bank rate decision

The Euro traded lower against the US dollar on an incredibly volatile week of trade, but the true fireworks are likely to come on a heavy string of economic event risk in the week ahead. Both the Euro Zone and the US economy have a key number of reports due within a short span, and markets are likely to force substantial moves in the Euro/US Dollar on any unexpected developments. Overall FX market momentum supports further euro losses and US dollar gains. Yet it will be important to watch any potential shifts in the week ahead.

Intense intraday volatility in the Euro/US Dollar could intensify on the coming week’s critical European Central Bank interest rate decision and several other second-tier releases. Consensus forecasts call for the ECB to cut its benchmark interest rate by 50 basis points to fresh record-lows of 1.50 percent, but uncertainty surrounding the event means that markets will force euro volatility regardless of the outcome. Overnight index swaps (OIS) currently price in a dead-certain 25 basis point cut and a 50 percent chance of a full 0.50 percentage point move. Regardless of the outcome, markets will pay very close attention to ECB President Jean Claude Trichet’s Question and Answer session following the announcement. The typically candid central banker already telegraphed a March rate cut in the same Q&A session following the January move, but questions remain as to whether the ECB will truly continue cutting rates to record lows. If there is any indication that the ECB will set an effective floor on its benchmark rate target, the euro would likely benefit vis a vis the low-yielding US dollar.

The euro will otherwise trade off of further financial market and macroeconomic developments—especially as they relate to Euro Zone stability. Wide European sovereign debt spreads underline the state of unease for many member countries, and ongoing fears of political fallout from the financial crisis bodes poorly for the euro itself. Recent rhetoric suggests that Germany and other major economies stand ready to bail out those countries at risk. Traders have nonetheless punished the euro for perceived instability, and any further deterioration in EMU affairs could send the EUR even lower against major counterparts.