The euro edged higher against the dollar on Wednesday, trading near 1.1640 and just under the week’s 1.1650 area. Support came after European Central Bank officials struck a hawkish tone: board member Isabel Schnabel said the bank can no longer look through the inflation spike and indicated a June rate move will be needed, while chief economist Philip Lane told Nikkei he sees no need for extra guidance and appeared relaxed about market expectations for tighter policy. Dollar advances were restrained as markets weighed hopes for a negotiated end to the US-Iran conflict, which has kept oil prices well below last week’s highs and reduced near-term pressure on Eurozone growth.

In the US, Dallas Fed president Lorie Logan said the next policy step could be either a hike or a cut, leaving the rate path open ahead of Thursday’s Personal Consumption Expenditure (PCE) Price Index. Technically, EUR/USD was at 1.1638, sitting below the top of a 10-day horizontal channel with the base around 1.1550-1.1560; the 4-hour RSI pointed to modest bullish momentum and MACD remained positive. A move above 1.1660 would target 1.1720 and then 1.1790, while support sits at 1.1615 and 1.1575, with a break exposing 1.1505-1.1525.

Policy Divergence and Inflation Fundamentals

With the European Central Bank signaling a likely rate hike in June, we see a clear divergence from the more cautious US Federal Reserve. This policy difference is the primary driver behind the Euro’s recent strength. This setup suggests that the path of least resistance for the EUR/USD pair is to the upside in the coming weeks.

We’ve noted that recent Eurozone inflation has remained sticky, with the latest figures showing core inflation at 2.7%, supporting the hawkish case for a rate increase. Meanwhile, the latest US Personal Consumption Expenditures (PCE) Price Index came in at 2.7%, which gives the Fed room to remain patient. This fundamental data strengthens our view that the Euro has more room to climb against the Dollar.

Trading Strategy, Risks, and Oil Market Backdrop

Given the potential for a breakout above the 1.1660 resistance level, we are looking at buying EUR/USD call options. A contract with a strike price near 1.1700 expiring in late June allows us to capitalize on a potential rally toward the 1.1720 or 1.1790 levels. This strategy provides upside exposure while limiting our maximum loss to the premium paid.

The main risk to this outlook is the upcoming US PCE data release this Thursday. A surprisingly high inflation print could quickly reverse the Euro’s gains. To mitigate this risk, we can use a bull call spread, which lowers the initial cost and breakeven point of the trade.

Furthermore, the potential for a US-Iran peace deal is providing a supportive backdrop by keeping oil prices down. We saw historically how the 2022 energy price spike hurt the Eurozone economy. Lower energy costs ease inflationary pressures in Europe and provide an additional tailwind for the Euro.