EUR/USD Hits Resistance at 1.0800 on Fed-ECB Policy Convergence

The Euro has seen significant demand as market participants anticipate a decrease in the policy divergence between the Federal Reserve (Fed) and the European Central Bank (ECB). Despite concerns of a recession in Europe, an ECB interest rate hike is anticipated.

Expectations of a softer US headline inflation due to a decrease in energy prices, while core inflation remains persistent, have contributed to the Euro's strength. This has pushed the EUR/USD pair closer to the key resistance level of 1.0800, following a strong recovery from 1.0743.

This week, the Euro is expected to experience volatility as ECB President Christine Lagarde announces the June interest rate decision. Similarly, the US Dollar is likely to see increased volatility as the Federal Reserve announces its interest rate policy on Wednesday. Prior to these announcements, significant market action is anticipated in the EUR/USD pair ahead of the release of the United States Consumer Price Index (CPI) data for May.

Market participants are closely focused on the US inflation data as it will provide important guidance regarding the Fed's policy. It is expected that monthly headline inflation will accelerate at a slower pace of 0.2% compared to April's 0.4% pace. However, core CPI, which excludes oil and food prices, is projected to remain steady at 0.4%.

The softening of headline inflation can be attributed to the negative impact from the energy component, while core CPI is expected to show persistence due to solid demand for durables and services. A weaker reading of US CPI would strengthen the case for a neutral interest rate policy announcement by the Federal Reserve, especially considering other factors such as the unemployment rate, jobless claims, and contraction in factory activities.

There are indications that the Federal Reserve may adopt a more cautious stance, as tight lending conditions imposed by US commercial banks are impeding inflationary pressures. Furthermore, President Joe Biden is set to announce the appointment of a Federal Reserve Vice Chair and fill the vacant Fed Board seat, which could influence the central bank's policy direction.

Meanwhile, ECB President Christine Lagarde is expected to raise interest rates by 25 basis points (bps) to 4.25%, despite concerns of a deepening recession in Europe. The final reading of the Eurozone's Q1 Gross Domestic Product (GDP) indicated a contraction of 0.1%, largely driven by declining factory activities. Germany, in particular, has already entered a recession after two consecutive quarters of contraction.

An ECB interest rate hike combined with an unchanged policy stance by the Fed would narrow the policy divergence between the two central banks. The US Dollar Index is currently defending its immediate support level of 103.35 amid positive market sentiment. From a technical perspective, the price has dipped below 1.0800, and a rebound at this resistance level with a subsequent pullback is possible.