06:25 AM EST, 01/03/2025 (MT Newswires) -- The fourth-quarter drop in EUR/USD was primarily driven by the widening in the short-dated swap rate differential due to diverging policy expectations between the United States Federal Reserve and the European Central Bank, said ING.

Over the Christmas holiday period and in particular, in Thursday's trading session, the EUR/USD decline accelerated in spite of a re-tightening in the EUR:USD two-year swap rate gap from 200bps on Dec. 12 to the current 185bps, wrote the bank in a note.

ING estimates that EUR/USD is trading around 2.5% below its short-term fair value, as such displaying a risk premium associated with growth concerns for the eurozone. Aside from the implications of expected U.S. protectionism under President-elect Donald Trump, the bank thinks pressure is being added by the rise in TTF natural gas prices to 50 EUR/MWh caused by Ukraine's pipeline shutdown.

Sterling (GBP) was the worst performer on Thursday, and it is probably not a coincidence that GBP is the most negatively correlated with gas in the G10, stated ING.

If the technical picture is pointing to a EUR/USD short-term rebound, the euro (EUR) remains a broadly unattractive currency in the longer run, and ING cannot exclude another leg lower might be needed -- perhaps to the 1.0200 mark -- before a recovery.

In the Central and Eastern European markets, the bank sees Poland's zloty (PLN) and the Czeck RFepublic's koruna (CZK) strongly following rates. While in Poland ING thinks current market pricing is fair, in the Czech Republic it believes markets are too hawkish relative to the Czech central bank's (CNB) stance.

While the CNB's next steps depend heavily on the January inflation number, ING believes the probability of rate cuts in February is higher than markets imply. Given the low EUR/CZK levels, the bank is also negative on the koruna and neutral on the zloty.

EUR/HUF gained 0.5% on Thursday, returning to higher levels, and ING sees the gap between rates and foreign exchange, closing. However, the bank still sees some room for the forint (HUF) to weaken and remains negative on it.

December inflation in Turkey Friday surprised to the downside with a drop from 47.1% to 44.4% year over year, below market expectations, added ING. Downside risk was indicated by inflation numbers from Istanbul on Thursday.

This is good news for Turkey's central bank (CBT) after the start of the cutting cycle last week. The month-on-month rate fell from 2.2% to 1.0%, while markets were expecting 1.6%. As a consequence, CBT can continue the cycle at the January meeting, according to the bank.

Although the market reacted strongly to the first central bank rate cut last week, especially at the front of the OIS and bond curve, we believe the market still has room to price in more cuts, particularly in this segment of the curve. TRY stabilised yesterday and today after holiday volatility and is returning to the traditional weakening trajectory of previous weeks. Despite the start of the FX carry cutting cycle, it remains attractive, which should keep market attention strong this year.