The EUR/USD reversed violently after hitting a high of 1.4719 today. I don’t think that it is a coincidence the currency’s rally stopped right at the 200-day SMA.

The euro’s recent rally is a testament to the impact of interest rates on currencies. We have long said that this is the number one driver of currency trends and the decline in liquidity near the end of the year has only exacerbated the rally.

Although the latest move in the Euro has some bank analysts revising up their EUR/USD 2009 forecasts to 1.60 and above, we want everyone to realize that the higher the EUR/USD rises, the more strain it will put on the Eurozone economy and the more reason it gives to the European Central Bank to cut interest rates. When the ECB first started to talk about pausing in January, the EUR/USD was trading around 1.26 and it has now appreciated 14 percent. Even though we also believe that the EUR/USD will continue to rise, we think that it may have a difficult time cracking above 1.48 and eventually, the trend will change. France’s largest bank BNP Paribas has been hit hard by the Madoff scandal. This is an example of the troubles plaguing European corporations. Consumer prices declined 0.5 percent last month, giving the central bank plenty of flexibility to cut interest rates if necessary.

The fact that the German IFO business confidence report also hit the lowest level since 1982 only confirms my belief. According to Barclays, the 11% rally in the trade weighted Euro is akin to a tightening of 175bp.

Watch out for a shift in ECB rhetoric. I still think that the US dollar is headed lower in 2009, but that does not preclude a retracement in the Euro that is driven by a surprisingly abrupt shift by the ECB’s stance on their January rate cut stance.

Kathy Lien is Director of Currency Research at GFT, and runs KathyLien.com.