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Dollar weakens on moderate inflation: EUR/USD outlook and monetary policy analysis, January 27, 2024

EUR/USD outlook and monetary policy analysis

Towards the end of the week, the dollar experienced a slight weakening due to recent data from the USA indicating a moderate rise in inflation in December. Despite this, the overall trend for the dollar remained downward. This particular scenario is likely to influence the Federal Reserve's decision to maintain a course aimed at lowering interest rates by mid-year. The impact of these developments on the future quotes of EUR/USD is a matter of consideration.

The Personal Consumption Expenditures (PCE) price index, a critical measure of inflation, reported a 0.2% increase in December following a 0.1% decline in November. The annual change in the PCE price index stood at 2.6%, aligning with both earlier and anticipated data. Notably, this marked the third consecutive month where the annual inflation rate remained below 3%, consistent with the Federal Reserve's inflation target set at 2%.

Jeff Klingelhofer of Thornburg Investment Management remarked, "Current data suggests that the market need not worry about immediate, significant increases in inflation. This trend potentially eliminates the need for further tightening of monetary policy, as noted by the Federal Reserve."

Analysts from MUFG offered mixed interpretations of US economic data in the context of monetary policy. Despite robust year-end data, doubts have arisen regarding the Federal Reserve's ability to initiate an easing cycle as early as March. Nevertheless, this possibility remains open, mainly due to favorable inflation data.

Following the release of the inflation report, US interest rate futures markets indicated a reduced likelihood of a rate cut in March compared to previous expectations. The market now appears more confident in predicting the first rate cut in May, with approximately five 25-basis-point rate cuts anticipated throughout the year.

Jonathan Petersen of Capital Economics highlighted that, despite strong recent economic data, mounting deflationary pressures continue to constrain bond yields and the dollar.

Petersen also observed that other central banks, such as the European Central Bank, are basing their decisions on market expectations, anticipating inevitable interest rate cuts in the coming months.

Danske Bank analysts emphasized, "While we acknowledge that our Fed (first cut in March) and ECB (first cut in June) forecasts, under the remaining assumptions, are positive for EUR/USD in the first half of the year, we believe that broader G10 valuations may be more decisive for crosses. This is due to our perception that current market expectations for interest rate cuts are excessive."

They concluded, "We still maintain our bullish stance on short-term EUR/USD gains and forecast EUR/USD at the level of 1.0700/1.0500 within a 6/12-month horizon."

eurusd daily chart, forex trading analysis
EUR/USD daily chart, MetaTrader, 27.01.2024


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