Euro hits fresh seven-month highEUR/USD rebound mirrors that of 2007That year it gained 10%

Image © European Central Bank

The Euro to Dollar exchange rate (EUR/USD) has shot to its highest level since June 2022 on an extension of a strong recovery driven by supportive Eurozone energy markets and a data-driven retreat in the Greenback, and further gains are possible says a prominent institutional analyst.

Chris Turner, who heads the FX analysis team at ING Bank, says "EUR/USD has been participating in this dollar sell-off and the bias looks higher".

EUR/USD started 2023 on a soft footing as it retreated from interim highs amidst a recovery by the under-pressure Dollar, but it retraced the weakness and burst to a multi-month best on Monday as investors rapidly discounted the prospect of an end to the Federal Reserve's interest rate hiking cycle.

At the time of this article's update, the pair has extended to 1.0745, reversing January's earlier losses to ensure it now sits on a 0.40% gain for the month with investors seeing a brighter outlook for the Eurozone amidst falling gas prices.

Indeed, Wall Street banking giant Goldman Sachs has said it has raised its economic forecasts for the region and no longer expects a recession.

Looking ahead, the rally can extend according to ING's Turner.

"Conditions here feel a little like the summer of 2007 when the slowdown in the US housing market saw the conviction build - especially from August 2007 onwards - that the Fed would have to ease," he says in a weekly research note.

Looking back at price action in 2007, Turner observes U.S. two-year yields crumbled to 2.70% having traded in a 4.50-5.00% range for the first half of 2007, and by the end of that year, EUR/USD had rallied around 10%.

The Dollar tracked U.S. yields higher in 2022 as global investors sought superior returns, therefore the Dollar would likely retreat if this dynamic on the bond markets was reversed, as is currently the case.

Above: EUR/USD at daily intervals showing the ongoing rebound. Consider setting a free FX rate alert here to better time your payment requirements.

"Of course, there are many differences between then and now, e.g. US sub-prime then, versus the US inflation battle now," says Turner. "But a surprisingly hawkish European Central Bank (both then and now) warns that EUR/USD could rally hard if the market is convinced the Fed will ease."

The ECB said in December it was prepared to hike interest rates by 50 basis points at least on two more occasions, catching the market by surprise as investors pondered whether Europe's central bank would slow down.

The Federal Reserve has meanwhile signalled it will soon ease back and investors are now expecting one more hike of 25 basis points, much less than what is 'priced in' at the ECB.

"The U.S. dollar started the week on the back foot, losing ground to other major currencies and approaching December’s lows. Investors have started pricing in a less aggressive stance from the Federal Reserve, following the release of jobs numbers on Friday that showed that, albeit unhurriedly, the US economy is starting to slow down," says Ricardo Evangelista, Senior Analyst at ActivTrades.

U.S. labour market statistics on Friday revealed a slowdown in the rate the U.S. is creating jobs while wage figures disappointed. But it was a sharp contraction in U.S. service sector activity that ultimately convinced markets a material slowdown was now underway and the Fed could therefore afford to rest.

Factors behind the Euro's rally include decreasing gas prices amidst warmer weather - which also brings stronger winds that drive wind turbines - and elevated gas storage levels.

This all eases the immediate risk of an energy crisis and lowers the nadir of any Eurozone economic recession.

"Low gas prices and China reopening are also supportive for EUR/USD and we would say that, despite the bearish seasonals for EUR/USD, pressure is building for further near-term gains," says Turner.

"With money probably flowing into emerging market funds now - and out of dollar deposits - we can see EUR/USD heading up to 1.0735/85, with outside risk to the 1.09 area should US price data soften again this week," he adds.