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Euro-dollar aims for parity amid Fed-ECB divergence

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The EURUSD currency pair finds temporary support in Friday’s trading after diving to near 1.0220 on Thursday, the lowest level in two years.

The Euro-dollar cross has resumed its phase of decline after breaching below the lower limit of the recent range (1.0330), Societe Generale’s FX analysts noted.

“Daily MACD has started posting positive divergence, but signals of a meaningful bounce are not yet visible. The high achieved earlier this week near 1.0460 is an important resistance near term,” the Societe Generale analysts added.

“Inability to cross this could mean persistence in downtrend towards next potential objectives located at projections of 1.0070 and 1.0000.”

Market experts see the major currency pair falling further to parity on Federal Reserve and European Central Bank divergent views on monetary policy outlook.

On the left side of the Atlantic, Fed officials have guided less interest rate cuts in 2025, while on the right, ECB policymakers see the continuation of the policy-easing cycle at the current pace.

According to the latest dot plot in the Fed’s Summary of Economic Projections, Fed officials see Federal fund rates heading to 3.9% by year-end. This indicates that policymakers expect two interest rate cuts this year, compared to four that had been forecast in September.

Market participants have also trimmed Fed dovish bets. They expect policies under President-elect Donald Trump’s administration, such as tight immigration, higher import tariffs, and lower taxes, to boost the growth rate and inflationary pressures in the US economy.

The DXY Dollar Index, which tracks the greenback’s value against six major currencies, edged down on Friday, but is still close to its highest level in two years, above 109.00.

Going forward, investors will pay close attention to a slew of US labour market-related economic indicators, which will influence Fed interest rate expectations. Currently, the Fed is almost certain to keep interest rates steady in the 4.25-4.50% range in January’s policy meeting.

In Friday’s session, the dollar will be guided by the US ISM Manufacturing Purchasing Managers Index (PMI) data for December. The PMI is expected to remain at 48.4, suggesting that manufacturing activities contracted at a steady pace.

ECB sees four rate cuts this year

EURUSD is unlikely to hold the immediate support of 1.0220 as traders have priced in 113 basis points (bps) interest rate reduction by the ECB this year. This suggests that there will be at least four interest rate cuts of 25 bps on the backdrop of deepening risks of Eurozone inflation undershooting the central bank’s target of 2%.

ECB officials are also comfortable with market pricing in four interest rate cuts.

On Thursday, ECB Governing Council member and Bank of Greece Governor Yannis Stournaras said in an interview on Skai Radio that the base interest rates of the central bank should fall to “around 2%” near the “autumn of this year”. This indicates that the ECB will cut its Deposit Facility rate in each of its next four policy meetings.

Apart from the risks of inflation remaining persistently lower, weak economic activity and the likely impact of a trade war with the US on the Eurozone’s exports sector have also boosted the ECB’s dovish bets.

On Thursday, the HCOB Manufacturing PMI for December, compiled by S&P Global, showed that manufacturing activity contracted at a slightly faster pace than the preliminary reading. The Manufacturing PMI came in at 45.1, compared to the flash estimate of 45.2.

Going forward, investors will focus on the preliminary German and Eurozone Harmonized Index of Consumer Prices (HICP) data for December, which will be released on Monday and Tuesday, respectively.

EURUSD chart by TradingView

(Source: OANDA)