EURUSD falls back from recent highsBut the setup remains constructivePotential for recent rally to resumeU.S. inflation will be key this weekWatch ECB's Lagarde on Friday

Image © European Commission Audiovisual Services

Although the Euro to Dollar exchange rate has retreated from highs at 1.0756, the technical setup remains broadly supportive, but any prospect of another run higher will likely hinge on midweek's release of U.S. inflation data.

Shaun Osborne, Chief Currency Analyst at Scotiabank, says the Euro-Dollar setup is neutral/bullish in nature ahead of the inflation release.

"Intraday price signals indicate the EUR may have based through overnight trade, with a bullish reversal pattern developing on the 6-hour chart around the overnight low just under 1.0660," he says in a recent note.

He says 1.0660 is near where the exchange rate picked up support earlier last week and could do so again.

"Broader patterns suggest a potential bull consolidation ahead of another push higher in the EUR after the early November recovery from the low 1.05s. Intraday EUR support is 1.0655. Resistance (bull trigger) is 1.0715," says Osborne.

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City Index analyst Fawad Razaqzada has created the above chart and finds that the short-term outlook for Euro-Dollar remains bullish, given the interim higher highs and higher lows we have seen of late.

"The fact that price is also holding above the 21-day exponential means the short-term trend is no longer bearish," he says.

Inflation forms the highlight of the week for the U.S. Dollar, with markets looking for a 0.1% month-on-month rise in inflation in October, down on the previous month's 0.4% gain.

Core CPI is forecast to remain unchanged at 0.3%. The rule of thumb is that should inflation beat expectations, the odds of another Fed rate hike increase and rate cut bets recede.

This will underpin U.S. bond yields and the Dollar.

"We think that markets would be very attentive to any evidence that inflation remained too sticky for comfort and thus force the Fed to 'engineer' a renewed tightening of US financial conditions, in a boost to the USD," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

The market will be particularly nervous heading into the release, given the strong pushback by Fed officials last week against what they perceive as premature expectations for rate cuts.

Above: Contribution to U.S. headline CPI y/y. Image courtesy of ANZ.

The Dollar rose after Fed Chair Powell warned on Thursday that the Fed "are not confident" interest rates are high enough.

"The focus now turns to next week’s CPI inflation report, which will shape bets around the interest rate path," says Marios Hadjikyriacos, Senior Investment Analyst at XM.com.

"In the bigger picture, the question facing traders heading into next year is which central banks will cut rates first and how deep those cuts will be. That’s a setup that favours the dollar, as the resilience of the U.S. economy suggests the Fed might be among the last ones to launch an easing campaign," he adds.

But there are other data releases due next week which all have the ability to impact the Dollar; these include:

Wednesday, 13:30 GMT: PPI (MoM) (Oct). Expected: 0.1%, previous: 0.5%Wednesday, 13:30: Retail Sales (MoM) (Oct). Expected: -0.1%, previous: 0.7%Thursday, 14:15: Industrial Production (MoM) (Oct). Expected: -0.4%, previous: 0.3%Thursday, 13:30: Philadelphia Fed Manufacturing Index (Nov). Expected: -11.0, previous: -9.0Friday, 13:30: Building Permits (Oct). Expected: 1.450M, previous: 1.471MFriday, 13:30: Housing Starts (Oct). Expected: 1.345M, previous:1.358M"While inflation is key, the focus on activity data should not be underestimated. Industrial production, retail sales, and housing will provide fresh insights about the state of the US economy for 4Q," says Dominic Schnider, Strategist at UBS.

On balance, we think the US data prints should be mixed with room for the USD to do well. We see risks of EURUSD trading below 1.07," he adds.

In the Eurozone, the focus turns to the release of third-quarter GDP, due for release at 10:00 GMT on Tuesday.

The market is looking for a reading of 0.1% year-on-year for the third quarter, down from 0.5% previously.

"The market focus with regards to Europe is likely to be on the upcoming GDP releases. High frequency data suggest the risks for the preliminary GDP figures for 3Q—advance figures earlier pointed to –0.1% q/q—could come in weak. The release is likely to reveal that the industrial sector in particular continues to struggle," says Dominic Schnider, strategist at UBS.

"As for the currency, we think the data will limit euro strength in the very near term," he adds.

Above: Christine Lagarde. Image by Dominique HOMMEL. © European Union 2019 - Source: EP

German ZEW economic sentiment surveys are in focus at the same time, with the market looking for the current conditions to read at -75 in November, a slight improvement on October, and the sentiment survey to read at 2.5, up from -1.1.

Such an improvement in sentiment could confirm the theory that the nadir in negative sentiment has been passed, a belief that has boosted the Euro over recent weeks.

European Central Bank (ECB) President Christine Lagarde is in focus on Friday as she is due to speak at 08:30 GMT.

"We expect ECB speakers to continue to push back against market rate cut expectations and reaffirm their commitment to get inflation under control. The EUR could benefit to the extent that the comments encourage rate investors to pare back rate cut bets," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

Last week we saw the Pound struggle after the Bank of England's Huw Pill validated market expectations for UK rate cuts from about mid-year, while the Dollar rallied after Federal Reserve Governor Jerome Powell fiercely fought back against any talk of rate cuts.

Central bank speak matters, and the Euro could move higher or lower depending on whether Lagarde does a Pill or Powell.