EUR/USD plunges on dovish ECB and delayed response to hawkish Fed

The EUR/USD spiked higher before coming under intense selling pressure in the immediate aftermath of the European Central Bank meeting as speculators judged the policy statement to be overall more bearish than bullish. In a way, the euro’s response was very similar to that of the dollar post the Federal Reserve rate hike yesterday. The dollar initially spiked higher as the Fed hiked rates as expected and in a hawkish move signalled that there will be two more rate increases to come in 2018. But the greenback couldn’t hold its initial gains and dropped sharply against the yen, pound and euro. However, the dollar’s post FOMC weakness proved to be temporary and driven by profit-taking. It came back to life on the back of a dovish ECB and as US retail sales beat expectations, which supported the case for aggressive rate hikes from the Fed. Indeed, the EUR/USD hit a post FOMC low of 1.1650 and was still falling at the time of writing.

The ECB was widely expected to announce end of QE and in this regard it didn’t disappoint. The Governing Council now expects net purchases under the asset purchase programme (APP) will continue at the current monthly pace of €30 billion until the end of September, before being reduced to €15 billion from October and finishing at the end of December.  However, the biggest surprise was the ECB’s outlook for interest rates, which was quite dovish. The central bank has stated it will keep interest rates unchanged at least until summer of 2019 and in any case for as long as necessary.

Previously, the market had expected there to be a rate hike in the first half of 2019, which is now no longer the case, by the looks of things. Indeed, after the soft Eurozone macro data for much of the first quarter and the uptick in inflation recently, the ECB was forced to revise its economic outlook and inflation forecasts. Instead of 2.4%, the Eurozone economy is now expected to grow 2.1% in 2018. In line with March forecasts, GDP in 2019 is expected to grow by 1.9% before moderating further to 1.7% in 2020. Meanwhile inflation is expected to average 1.7% for the Eurozone in 2018, instead of 1.4% predicted in March. Inflation in 2019 and 2020 is expected average 1.7% in both years. ECB President Mario Draghi said in his press conference that the economic slowdown has been compounded by an increase in uncertainty, “temporary supply-side shock” and a “weaker impetus” for trade.

Following the ECB policy decision, the EUR/USD dropped from a high of 1.1850 to a low so far of 1.1640. That’s more than 200 pips! The big fall keeps the bearish trend intact and another test of the bullish trend line thus remains likely. However, for the resumption of the bearish trend to be confirmed, the bears will require a break below the most recent swing low. Specifically, a decisive move below 1.1550 is required to confirm the recent EUR/USD recovery was just a pullback in what is a bearish trend. Otherwise the false break pattern that had been created at the end of May will remain technically valid. In any case a move back above 1.1850 would end the bearish bias. Ahead of that, the now broken 1.1730 is now the most important short-term resistance for the bears to defend.