EUR/USD faces downside risks amid Middle East unrest

On Friday, analysts from ING have noted an increase in downside risks for the currency pair, warning that the 1.0600 support level might soon be breached. The current geopolitical tensions in the Middle East are believed to be overshadowing factors related to the European Central Bank (ECB), potentially leading to a bearish outlook for the euro against the dollar.

The analysts pointed out that while the euro is less vulnerable than some other currencies to the unfolding events in the Middle East, a significant rise in energy prices could prompt a shift to a more structurally bearish stance on EUR/USD.

Despite the euro’s stronger trade terms and economic fundamentals compared to the previous year, which do not suggest an immediate move towards parity with the dollar, there is a possibility that the markets could start pricing in a worsening of the Eurozone’s economic conditions due to elevated geopolitical risks.

The impact of ECB’s decisions on the foreign exchange market is also under consideration, with two main scenarios outlined. In the event of an escalation to full-blown conflict in the Middle East leading to a major equity correction and commodities rally, any delay in ECB’s plans to ease monetary policy is unlikely to provide much support for the euro.

This is reminiscent of 2022 when despite significant rate hikes by the ECB, the euro remained under pressure. Alternatively, if the geopolitical situation does not cause a major shock to equities and commodities, then the ECB’s decision regarding interest rate cuts could play a more influential role in determining the direction of EUR/USD.

As the situation in the Middle East continues to be closely monitored, the analysts have emphasized that the risk of a decline in EUR/USD has undoubtedly increased as of Friday, and the key support at 1.0600 may be tested sooner than anticipated.

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