EUR/USD outlook: ECB set to deliver 25 basis point cut

EUR/USD was down on the day at the time of writing, slipping below the key 1.05 level as earlier gains evaporated, putting the pair on track for its fourth consecutive losing day. Yet, with the European Central Bank rate decision looming, traders will be less keen to push the pair too low. A rebound could be on the cards, therefore. Anyway, the latest US CPI data came in line with expectations earlier, cementing the market's belief that the Federal Reserve is set to cut interest rates during its meeting next week. This helped to strengthen the dollar initially, putting pressure on weaker currencies like the euro. But with December being historically a bearish month for the greenback, let’s see if we will finally see some USD-selling heading into year-end. Meanwhile, traders are eyeing the European Central Bank, which is set to announce its interest rate decision tomorrow. Market participants are eager to see if the ECB will maintain its cautious stance or signal any changes in policy amid the ongoing economic challenges in the Eurozone. This week’s developments could set the tone for EUR/USD outlook in the coming weeks.

US CPI cements rate cut expectations

Today’s US inflation data showed no upside surprises and that meant traders got the trigger they needed to cement their expectations for a rate cut at the Fed’ last meeting of the year next week. Indeed, according to the CME’s FedWatch tool, the odds of a 25 basis point cut increased to more than 96% after the CPI release. This means that the Fed will cause a major shock if it now decides against a cut. Put another way, a rate cut is now a foregone conclusion, and we don’t have any major US data until the FOMC’s meeting next week to influence their decision. Therefore, the key question is whether the central bank will then hit the pause on rate cuts in early parts of 2025 or continue cutting at the current pace of 25 bps. Assuming the Fed goes ahead with a 25 bps cut next week to lower the Fed rate to a range of 425-450 basis points, the market is only attaching a 22% probability of an additional cut on January 29 at the FOMC’s next meeting. It looks like rates traders are expecting – with a 72% probability – for the next rate cut to take place at the Fed’s second meeting of 2025 on 19 March.

ECB set to cut rates by 25 basis points 

The other, perhaps bigger, spotlight for EUR/USD traders this week is the European Central Bank’s rate decision on Thursday, now that the US CPI is out of the way. Analysts widely expect a 25-basis-point rate cut, which would bring the deposit rate down to 3.15% from 3.40%. While some speculated about a more aggressive 50-bps cut, a measured approach seems more likely, leaving the door open for further easing in 2025.  That is something that President Lagarde could signal and potentially provide the next leg of the selling in the EUR/USD and other euro pairs. However, a lot of the ECB’s dovishness is now priced in. Watch how the EUR/USD closes the session tomorrow and that could provide you lots of ideas in terms of directional bias heading into year-end.

Recent soft data releases including Monday’s weak Sentix Investor Confidence have all helped to bolster the case for continued dovishness. Adding to the challenges, political uncertainty is weighing on economic sentiment, with budget negotiations in Berlin and Paris hitting an impasse. Should the ECB strike a more dovish tone than markets are expecting, the EUR/USD could face additional downside pressure.  But the fact that it has managed to hand around the 1.05 handle despite all the stuff going on in Europe, the euro may be closer to a bottom than it feels like right now.

Technical EUR/USD outlook: Trade ideas and levels to watch

Source: TradingView.com

So, the EUR/USD continues to trade under pressure but because of the macro reasons stated above, a potential bottom could be made soon. For now, the focus remains on what it does around the 1.05 handle. The pair has repeatedly failed to rally away from here and is now back below this psychologically important level again. Price action is therefore heavy for now. Thus, if we go below the last low prior to the recent up move at 1.0472, this would be a further bearish development. Should that happen, then I would expect the EUR/USD to potentially re-test its November low of 1.0333 and possibly head further lower.

Meanwhile, the bulls will need to remain patient and await a confirmed bullish signal. The EUR/USD has tested the 1.06 resistance zone (1.0595–1.0610) but has yet to break through it decisively. A successful push above this level could trigger a short-squeeze rally toward 1.0700, with potential further upside targets around 1.0780.

This is one of the two potentially bullish scenarios I am eyeing right now. The other one would be if we break below the November low of 1.0333 but quickly reclaim that level to form a false break reversal pattern. Either way, confirmation is needed. Thus, for the time being, my favourite strategy on this pair remains to look for bearish setups at resistance (old support levels).

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R