The correction of the dollar, which is likely to be observed this week, will provide a chance for the euro and the pound to recover. The economic calendar for the US is weak, with markets this week only showing minor data such as building permits, existing home sales, home builder confidence and a couple of regional producer surveys. Statements from representatives of the Federal Reserve are also not to be expected, since now there is a week of silence before the central bank meeting.
The dollar has benefited greatly in recent months from investors' fears of a pending recession, as well as aggressive Fed rate expectations. At the same time, the latest economic data and comments from Fed officials have confused the market.
The euro may be weathered by the European Central Bank meeting on Thursday and related events in European natural gas markets.
"The main risk for the trade idea in the new week will be that the ECB will undertake a more decisive tightening by raising rates by 50 bp, and market participants will positively perceive the ECB's plans to combat policy fragmentation," MUFG analysts suggest.
If the central bank's plans to tackle policy fragmentation do not live up to expectations, and Italy eventually has to hold early elections, the fundamental case for a recovery in the euro will be offset. Recommendations for short positions will be relevant again for the EUR/USD pair.
The day before the ECB meeting, a vote will be held in the Italian parliament, which should determine whether early elections will take place. This, according to many analysts, could lead to a depreciation of the euro.
Traders also keep the focus on gas topics. Russian natural gas deliveries via the Nordstream 1 pipeline are expected to resume on Thursday after an ongoing 10-day technical shutdown. This alignment will have a significant impact on the outlook for European economies and ECB interest rate policy in the coming months.
"The rationing of gas supplies due to the interruption of imports from Russia implies stagflation in the style of the 1970s in the eurozone. This could trigger a recession several blocks long. We estimate the peak impact on GDP at around 2.5 p.p. below our baseline forecast," writes BNP Paribas.
The ECB initially signaled to markets that it would raise rates at its July meeting. However, the euro failed to capitalize on the landmark change in monetary policy. It is difficult to imagine that even with a tougher approach on Thursday, the single currency will be able to take a confident course for recovery.
The ECB is expected to raise rates by 100 bp this year. Taking into account market pricing at the interest rate, the ECB will pull it up to 1.25% by May 2023. The risk for the euro bloc and the single currency remains downward, the bearish position is in force.
In the short term, the outlook for the euro is positive. EUR/USD is expected to rebound to 1.0200 amid oversold conditions. Once the downward trend resumes, resistance will be met at key parity ahead of the 2022 low at 0.9952 on July 14.
As long as the quote moves below the 5-month support line around 1.0540, further losses await the euro. On the long-term horizon, the bearish view on EUR/USD will prevail if the pair is below 1.1026.
Pound: short-term presentable
The pound also started the week in a good positive, gaining more than 1% of the value intraday. It may further regain lost ground, approaching 1.2000 in the coming days if the market's softer Fed rate outlook continues to weigh on the dollar.
The lack of notable events in the US calendar also plays a role. Traders will switch to a loaded UK data calendar and market risk appetite.
The short-term trend for the pound is bullish. Although the GBP/USD pair is likely to face strong resistance around 1.2050 as well as 1.2065. A break above is needed to open the way for further growth. Immediate support lies at 1.1950, followed by 1.1920 and 1.1850.
Long-term prospects for the GBP/USD pair are still negative. JP Morgan remains bearish on the pound, recommending sell on the rally.
As for monetary policy in Britain, so far the data has not allowed officials to raise rates more aggressively. A recent portion of reports may change the priorities in the central bank. In May, the GDP was higher than expected, and the figures for the previous months were also revised upwards. At the same time, gas futures have doubled since the beginning of July.
The new reports should help the Bank of England decide on further steps – to raise the rate by 25 bps or 50 bps. At the same time, some analysts tend to believe that an increase of 50 bps is practically a foregone conclusion.
The data on employment in the UK for May will be released on Tuesday, and the inflation report for June on Wednesday. Both indicators play a big role. Another unexpected increase in inflation will reinforce market expectations that the BoE will raise rates more sharply at its August meeting, according to MUFG.
The consensus assumes an increase in annual wages (excluding bonuses) from 4.2% to 4.3%. The inflation rate in the UK will rise from 9.1% to 9.3%.