All eyes on ECB for EUR/USD direction

Both the technical and fundamental aspects relating to this currency pair have led to the demise of the euro in the past week.

It’s well-known that overly-heightened inflation levels are a problem, as they technically reduce the power your money possesses.

To the man on the street, deflation implies that the purchasing power of a currency has increased, and therefore that prices will go down. This is often mistakenly construed as a positive. If this macroeconomic condition is sustained, company profits begin to decline. This can have a ripple effect, and may adversely impact employment levels after a period of time. The worst part about deflation in the current climate is that the already extreme levels of debt become yet more problematic. High debt-to-GDP ratios result for some of the more indebted nations.

The European Central Bank (ECB) has a mandate to maintain price stability, and the fall in the CPI (consumer price index) to 0.7% in October, from 1.1% in September, tends to imply that the bank will need to act quickly if this is to be solved. The ECB meeting later this week will now be more closely watched than ever, given that many investment banks are anticipating a rate cut from the central bank in order to stem the deflationary spiral. I would personally question the long-term value of any rate cut, particularly if certain ECB members are stating that interest rates are already too low for Germany.

There was some good news for Europe today, in that the manufacturing sector continues to recover modestly, with expansionary signals in all nations bar two.

The failure to break above the 1.3833 level has now seen EUR/USD test the 1.35 level, having shed just under 3% in the past week. For now the 1.3490/1.35 level is seeing the euro find some bids. This is the 50% Fibonacci retracement from the April 2011 highs to the July 2012 lows, so I would expect a bounce from here.

Rising support from a trend line coming from the July lows is currently being tested, and thus should we see any daily close below 1.3460 it could invite some increased downside for the euro. One could expect a near-term target on the downside to come from the 100-day moving average at 1.3396.

EUR/USD chart

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