Sunday 23 October 2016

Euro falls as Draghi revamps his quantitative-easing programme

Eshe Nelson

Published 06/09/2015 | 02:30

Mario Draghi's move to revamp his quantitative-easing plan sent the Euro dropping to a two week low
Mario Draghi's move to revamp his quantitative-easing plan sent the Euro dropping to a two week low

Mario Draghi has finally bought Europe some relief in foreign-exchange markets. The European Central Bank president sent the euro tumbling to a two-week low after he revamped his quantitative-easing plan and signaled officials might expand stimulus if the global market rout continues to weigh on growth and inflation.

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Some analysts now believe that the euro may fall to parity versus the dollar.

A weaker currency will console officials struggling to prevent consumer prices from falling and trying to boost productivity. The euro had emerged as an unlikely haven in recent weeks, jumping almost 3pc against a basket of its Group-of-10 peers in the past month as investors are attracted by the currency union's record current-account surplus.

"The longer term risks for the euro are firmly on the downside with the ECB considering sticking with QE for longer," said Valentin Marinov, head of Group-of-10 currency research at Credit Agricole SA's corporate and investment-banking unit in London. Signs that the euro will weaken further are returning.

Investors boosted the premium for options protecting against a decline by the shared currency last week, compared with those guarding against an increase, one-month risk-reversals show.

"If the situation continues to deteriorate, then the hurdle for further easing has been lowered," said Lee Hardman, a currency strategist at Bank of Tokyo-Mitsubishi in London. Hardman said the euro may fall to $1.10 in the short term and reach parity during the next 12 months. Analysts at Citigroup Inc. and Deutsche Bank AG - the two biggest currency traders - also project a drop to parity.

Until recently, the ECB's stimulus, which included a €60bn monthly bond-buying program, had helped depress the euro. Between December and July, the currency weakened more than 9pc against the dollar, falling below $1.05. A measure of market inflation expectations also rose during that period.

Then global events superseded the ECB's measures. The euro advanced to $1.17 as investors embraced it as a haven and unwound carry trades that involved buying higher-yielding assets abroad. The five-year, five-year forward inflation swap rate, a market metric identified by Draghi as a benchmark for the inflation outlook, retreated last month to 1.6pc.

"The ECB are unhappy with the late-August euro strength and would lean against future global uncertainty-led rallies," said Josh O'Byrne, a London-based strategist at Citigroup.

A stronger currency has the potential to push down consumer prices, which grew just 0.2pc in July from a year earlier against the ECB's target of close to 2pc. The ECB also cut its growth and inflation forecasts for the euro zone at its Thursday meeting, after keeping interest rates at a record low.

Prices are under pressure from a China-spurred meltdown in emerging markets and a decline in oil prices. Financial market volatility surged after China devalued its currency last month, while more than $7.7 trillion was wiped off of global stock markets.

"Taking into account the most recent developments in oil prices and recent exchange rates, there are downside risks" to the latest inflation forecasts, Draghi said at a news conference in Frankfurt. Stimulus will continue until the end of September 2016 "or beyond, if necessary," he said, in a change of language that hinted more strongly than before at a readiness to prolong purchases.

Analysts have raised their year-end forecast of the euro by 2 cents to $1.07 during the past month, according to the median estimate of data compiled by Bloomberg. The common currency has been the second-best performer of 16 major peers during the period as a rout in emerging markets prompted investors to seek safer assets. Goldman Sachs still predicts the euro will weaken to 95 cents in the next 12 months and slide to 80 cents by end-2017, once risk aversion abates.

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