EUR/USD in midst of bearish breakdown on chartsLoss of support near 1.1292 warns of further lossesAs USD looks to extend on repricing of Fed outlookEUR lags as scope for ECB policy shift seen limited

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The Euro to Dollar rate entered the new week having ceded an important level of technical support, leaving it at risk of a bearish breakdown on the charts during a period in which light trading volumes could potentially prompt outsized moves heading into the festive break.

Europe’s single currency enjoyed a short-lived rally back above 1.13 late last week when the Dollar fell broadly in the wake of Wednesday’s Federal Reserve policy decision and after the Euro was lifted by last Thursday’s European Central Bank (ECB) decision.

The ECB’s plan for a managed phase out of its €1.85 trillion Pandemic Emergency Purchase Programme between March and October next year was followed by a market bid for the Euro, although one that failed to lift the Euro-Dollar rate far enough off its recent lows to alter its apparent trajectory.

“President Lagarde seems to have successfully conveyed the message that the ECB will continue to tolerate higher prices in 2022 without any tightening or significant acceleration in tapering. That is key to keeping peripheral spreads in check, but also suggests the ECB won’t close the gap with the Fed in the foreseeable future, which should keep a lid on EUR/USD in the new year,” says Chris Turner, regional head of research for UK & CEE at ING.

While the ECB lifted its inflation forecasts across the board on Thursday, the bank otherwise stuck with the view that recent increases in price growth to record highs are likely to fade away of their own accord next year without requiring a monetary policy response.

Above: Euro-Dollar rate shown at daily intervals with Fibonacci retracements of September decline indicating likely areas of resistance.

EUR/USD reference rates at publication:

Spot: 1.1268High street bank rates (indicative band): 1.0874-1.0952Payment specialist rates (indicative band): 1.1167-1.1212Find out about specialist rates, hereSet up an exchange rate alert, hereBook your ideal rate, hereThis came hard on the heels of a ‘hawkish’ privot that saw the Fed accelerate the tapering of its quantitative easing programme so that it finishes in March 2022 rather than June and warn that its interest rate could begin to rise sooner than was previously thought likely.

“This is the third consecutive set of dots that have seen a more hawkish shift and in our view this momentum will continue to support the USD. While 1y forward rates pricing has moved notably higher, it is still a fair way below current estimates of the “terminal” rate in the US. This leaves space for further hawkish shifts in the future, which should also be USD supportive,” says Dominic Bunning, European head of FX research at HSBC.

“The reality is that ECB balance sheet expansion is still running ahead of its peers and asset purchases will be ongoing when others are well into their hiking cycle. As such we don’t think we have reached peak policy divergence yet and EUR has room to fall further,” Bunning said in a Friday note.

The Fed’s December dot-plot suggested a majority of U.S. policymakers see the bank as likely to lift interest rates as many as three times next year, possibly taking the Fed Funds rate range to between 0.75% and 1% by the time the ECB has fully wound down its PEPP programme.

While the Dollar fell widely following December’s Fed decision, the prospect of a growing gap between the Fed and ECB next year is something that many analysts see as supportive of the greenback and likely to keep the Euro-Dollar rate under pressure over the coming months.

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“Overall, we expect that USD upside has further to run in the early months of 2022 as the Fed winds down its bond buying programme and moves closer to its first rate rise of the cycle. Consequently, we have revised down our 6 month EUR/USD forecast to 1.10 from 1.12,” says Jane Foley, head of FX strategy at Rabobank.

“That said, with a lot of good news already in the price, we are concerned that the momentum behind the Greenback’s rally may run out of steam in the latter part of next year and see scope for the USD to have given back a little ground vs. the EUR on a 12-month horizon,” Foley wrote in a review of Rabobank’s EUR/USD forecasts last week.

The Euro-Dollar rate entered the new week back below 1.1292, which coincides with a major level of technical support on the charts and potentially leaves it at risk of further declines over the coming days.

Thursday’s PCE inflation figures from the U.S are the highlight of the week ahead, and the Dollar could be sensitive to whether the number rises further above 5% as this could lead the market to bring forward the time at which it expects the Fed Funds rate to begin rising.

That would be a downside risk for the Euro-Dollar rate in a week ahead that is otherwise devoid of major events in the economic calendar, but which is also likely to be marked by choppy conditions as the festive period approaches and trading volumes fall.

Above: Euro-Dollar rate shown at weekly intervals with Fibonacci retracements of 2020 recovery indicating likely areas of technical support, and U.S. Dollar Index.