EUR/USD falls to near 1.0600 amid speculation for extension in Fed-ECB policy divergence

• EUR/USD drops to 1.0600 as the Fed is expected to pivot to rate cuts after the ECB.

• Eurozone’s weak economic outlook and cooling inflation fuel ECB rate cut bets.

• Fed policymakers emphasize keeping interest rates higher until they are sure about inflation returning sustainably to 2%.

The EUR/USD pair trades close to more than a five-month low near the round-level support of 1.0600 in the European session on Tuesday. The major currency pair is vulnerable to further downside as investors see the policy divergence between the Federal Reserve (Fed) and the European Central Bank (ECB) extending further.

Market expectations for the European Central Bank (ECB) to begin reducing interest rates from the June meeting have escalated. The weak Eurozone economic outlook and consecutive cooling core inflationary pressures for eight months have increased the likelihood of the ECB pivoting to rate cuts.

Last week, ECB President Christine Lagarde said if a fresh assessment increase policymakers' confidence that inflation is heading back to target, then it "would be appropriate" to cut interest rates, Reuters reported. ECB Lagarde delivered the statement in an interview post policy meeting in which the Main Refinancing Operations Rate was kept unchanged at 4.5%.

Meanwhile, traders have priced out expectations for Federal Reserve (Fed) rate cuts in the June and July policy meetings as core United States inflation remains stronger than expected in three months this year. This has strengthened the argument that the Fed should keep interest rates restrictive for a longer period.

Currently, investors expect that the Fed will start reducing interest rates from the September meeting. The Fed pivoting to rate cuts later than the ECB will stretch the policy divergence.

Going forward, speeches from various Fed policymakers will guide market expectations for Fed rate cuts. Fed policymakers are expected to support keeping interest rates higher until they are convinced that inflation will sustainably return to the desired rate of 2%.