EUR/USD Weekly Forecast: A test of 1.1000 remains on the cards in key central bank week

Despite having touched its highest level since April above 1.0900 at the beginning of the week, EUR/USD has struggled to gather further bullish momentum. The Federal Reserve (Fed) and the European Central Bank's (ECB) policy meetings next week could trigger the next directional move in the pair. 

What happened last week?

Hawkish comments from ECB officials allowed EUR/USD to gain traction and touch its highest level in nine months near 1.0930. ECB policymakers Klaas Knot and Peter Kazimir both said that they were in favour of two more 50 basis points (bps) rate hikes in February and March. On the same note, "We have made it clear that ECB interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive and stay at those levels for as long as necessary," ECB President Christine Lagarde reiterated while speaking at a conference in Germany on Monday.

On Tuesday, the data from the Eurozone showed that the business activity in the Eurozone expanded modestly in early January, with S&P Global Composite PMI edging higher to 50.2 from 49.3 in December. Later in the day, S&P Global reported that Composite PMI in the US edged higher in the same period but remained well below 50, coming in at 46.6. Commenting on the data, "the rate of input cost inflation has accelerated into the new year, linked in part to upward wage pressures, which could encourage a further aggressive tightening of Fed policy despite rising recession risks," noted Chris Williamson, Chief Business Economist at S&P Global Market Intelligence. This comment helped the US Dollar limit its losses and capped EUR/USD's upside.

In the absence of high-impact data releases, the Euro benefited from ECB commentary and managed to push higher mid-week. ECB policymaker told Bloomberg that the ECB should continue with 50 bps rate increases amid growing wage pressures and Governing Council member Gabriel Makhlouf echoed Lagarde's remarks by saying that rates will have to rise significantly at a steady pace.

On Thursday, the data published by the US Bureau of Economic Analysis revealed that Gross Domestic Product (GDP) in the US expanded at an annual rate of 2.9% in the fourth quarter, down from the 3.2% growth recorded in the third quarter. This reading surpassed the market expectation of 2.6% and provided a boost to US Treasury bond yields. In turn, EUR/USD retreated below and snapped a six-day winning streak.

The cautious market mood and profit-taking ahead of the weekend helped the US Dollar hold its ground on Friday and caused EUR/USD to continue to stretch lower on Friday. Meanwhile, Annual Core PCE inflation declined to 4.4% in December from 4.7% in November, matching the market expectation.

Next week

On Monday, fourth-quarter GDP data from Germany will be featured in the European economic docket. The German economy is expected to post a contraction of 1.1% on a quarterly basis in Q4. On Tuesday, Eurostat will publish the GDP data for the Eurozone, which is forecast to arrive at 2.2% on a yearly basis in Q4. Ahead of the key central bank meetings, however, investors are unlikely to take positions on these data.

On Wednesday, the Fed is widely anticipated to hike its policy rate by 25 bps to the range of 4.5-4.75%. The 'Fed pivot' narrative has been dominating the action in the financial markets and weighing on the US Dollar since December. Although Fed policymakers, including Chairman Jerome Powell, noted that they were not even thinking about cutting rates in 2023, the market positioning suggests that investors remain optimistic about a dovish move later in the year. Powell is likely to try his best to keep investors in line by reiterating the risk of wage inflation feeding into inflation expectations and their intentions to keep the rate steady for the rest of the year once they stop hiking it.

At this point, it will take more than repeating that same message to convince market participants that the Fed will keep its policy tight throughout the year. In case Powell pushes back against the market expectation and opens the door for a 25 bps rate hike in May, this could be seen as a hawkish development and cause EUR/USD to fall sharply.

On the other hand, the fact that the US Dollar Index is already down more than 10% since November suggests that a fresh bout of US Dollar selling could be hard to come by unless there is a significant dovish surprise. Although there is more room for the US Dollar weakness, investors could opt to wait for the January inflation and employment data, or even March's Summary of Economic Projections, before continuing to short the Greenback.

On Thursday, the ECB will announce its interest rate decision. A 50 bps rate hike by itself is unlikely to trigger a significant reaction. If the policy statement or ECB President Lagarde confirms that there is a high probability of one more 50 bps hike in March, that could help the Euro outperform its rivals. More importantly, EUR/USD could register impressive gains in case Lagarde suggests that rate hikes will continue into the second half of the year. 

Ahead of the weekend, the US Bureau of Labor Statistics will publish the jobs report. Nonfarm Payrolls (NFP) are forecast to rise by 175K in January, according to Reuters. In December, NFP came in at 223K and beat the market expectation of 200K. The wage inflation component of the report showed that Average Hourly Earnings grew by 4.6% on a yearly basis, down from 5% in November. In turn, the US Dollar failed to capitalize on the upbeat NFP print and suffered losses against its rivals amid soft wage inflation figures. Hence, a similar market reaction could be witnessed on Friday. A decline in annual wage inflation, especially if it's coupled with a weaker-than-expected increase in NFP, could weigh on the US Dollar. On the other hand, a sharp increase in wage inflation should help the currency stay resilient against its rivals even if the headline NFP arrives below the market consensus.

EUR/USD technical analysis

EUR/USD dropped toward the lower limit of the ascending regression channel coming from early October but managed to stay within it. Additionally, the Relative Strength Index (RSI) indicator on the daily chart holds comfortably above 50 and the pair trades above the 20-day SMA, suggesting that the latest pullback is a technical correction rather than the beginning of a reversal.

On the upside, interim resistance seems to have formed at 1.0930 (static level). Above that level, 1.1000 (psychological level, mid-point of the ascending channel) aligns as the next hurdle before the pair could target 1.1150 (upper limit of the channel).

In case EUR/USD makes a daily close below 1.0850 (lower-limit of the channel), it could extend its correction toward 1.0800 (psychological level, 20-day SMA) and 1.0630 (50-day SMA).

EUR/USD forecast poll

FXStreet Forecast Poll doesn't point to a consensus among polled experts for EUR/USD's short-term outlook. The average target on the one-week aligns at 1.0869 with half of the experts forecasting bullish action while 42% seeing the opposite. The one-month outlook reveals a bearish view with the average target sitting slightly above 1.0700.