EUR/AUD: Path of least resistance is to the downside, targetting 50% retracement

• EUR/AUD is en route to the downside correcting latest daily rally.
• EUR/AUD targets a 50% retracement on RBA ECB divergence and the prospect of a trade truce.

EUR/AUD dropped from the July highs as markets start to factor on easing from the European Central Bank. The Australian and Chinese data managed to keep within relatively acceptable levels where markets would not go out of the way punch the Aussie ahead of the Federal Reserve Interest rate decision overnight. 

EUR/AUD's fate depends on the race to the bottom between the ECB and RBA

Trimmed mean inflation for Q2 printed in line with expectations (market’s and the RBA’s), while headline inflation was slightly stronger than the market expected. Governor Lowe’s speech last week suggested the RBA is prepared to watch the data for a period to determine whether “we’re going to need further stimulus”. For the RBA, it likely gives more time before action is required and a move next week now seems materially less than a 50% probability. 

"The Q1 CPI data were in line with the RBA’s forecasts, so there is no smoking gun here," analysts at ANZ bank argued. "The RBA’s forecasts to be published in the Statement on Monetary Policy next week will assume two further rate cuts (reflecting current market pricing)." However, the analysts argued that it is very difficult to see how the Bank will achieve its target of 4.5% unemployment in a timely manner without further easing. "Consequently, we continue to expect another cut in the next few months, the exact timing of which we will firm up after next week’s RBA statement."

Meanwhile, when looking to the European Central Bank, the latest flurry of EZ data will be important for Draghi & Co. given how fragile the economy is and the downside 0.1% miss in core CPI and the ECB's focus on underlying inflation and inflation expectations, it will help to make the case clearer for an additional round of stimulus in September. We also had Q2 GDP data for Spain, Italy and the Eurozone, as well as July inflation for France, Italy, and the Eurozone. All in all the data was a little underwhelming. EZ GDP came in line with consensus at 0.2% q/q although though headline CPI met expectations at 1.1% y/y.

Trade talks to prop up the Aussie

All in all, EUR/AUD is not going to find buyers at this rate, not while EUR/USD's ship is going down an in an era of the carry. If the RBA holds off from cutting rates next week and should there be any prospects at all of a trade deal between China and the US, then commodities should continue to find support, (AUD trades as a proxy tot he commodity complex).

 "The US and China ended trade talks in Shanghai without any meaningful progress, highlighting the reality that a deal is far from being reached. Both parties agreed to meet again in September," analysts at ANZ Bank noted. 

Some latest news has crossed the wires from Xinhua arguing that the U.S. can push forward trade talks on the basis of equality. Earlier, we had Hu Xijin comment that the next round of China-US high-level trade consultations will be held in Sept and, "based on what I know, the two sides will hold intensive working-level consultations in Aug. This arrangement shows Wed's talks were not bad. It is not accurate to say the talks ended up in a bad vibe."

EUR/AUD levels

Technically, the path of least resistance is to the downside in the short-term although the pair is changing hands in a broader bull trend which started back in 2013 following the RBA taking action against a strong Aussie (over 1.05 to the Dollar) by cutting interest rates. However, the RBA will be reluctant to cut rates too soon and run out of room to do so again should there be some economic shock down the line. This gives rise to the case for the downside in EUR/AUD for the near term and 1.6080 meets a long term trendline as well as a 50% Fibo retracement of the latest rally in July.  A beka there opens the case for a reversal targetting 1.5980 and then the 200-day moving average around the 1.5950/60s.