The case for European Central Bank action to curb the euro’s gains is getting stronger after the 18-nation currency jumped to within a half-cent of $1.40.
“A print of $1.40 is a psychologically important level which may set off some alarm bells to officials,” Neil Jones, the head of hedge-fund sales at Mizuho Bank Ltd. in London, said in a May 2 phone interview.
ECB President Mario Draghi stepped up his war of words against the euro’s gains in recent months, culminating in an April 24 pledge to start asset purchases if a stronger currency keeps inflation depressed. While the appreciation may be seen as a referendum on Draghi’s role in the euro area’s recovery from its sovereign-debt crisis, evidence is building that exporters are suffering.
Amsterdam-based Royal Philips NV, the world’s largest lighting company, last month blamed the euro in part for first-quarter earnings that fell short of analysts’ forecasts. Firms from Royal Bank of Scotland Group Plc to Amundi Asset Management say $1.40 may test policy markers’ resolve, and Bank of New York Mellon says a breach of that level may send the currency even higher.
The euro climbed to $1.3951 yesterday, approaching the 2 1/2-year high of $1.3967 reached March 13, and was at $1.39195 as of 12:07 p.m. in New York. It has appreciated about 8 percent against a basket of nine developed-market peers since the end of March 2013, based on Bloomberg Correlation Weighted Indexes.
“If the euro starts to strengthen again, it could go significantly higher, even toward $1.45 or $1.50,” Neil Mellor, a London-based currency strategist at BNY Mellon, said in a May 1 phone interview. “You could speculate that there are many people out there who’ve been betting against euro strength and will have to capitulate if the euro breaks $1.40.”
The euro is near its strongest level since Oct. 31, 2011, when it rose to $1.4171. That was a day before Draghi took over as head of the Frankfurt-based central bank.
Almost no one predicted the rally. Even with the gains, just five of 56 analysts surveyed by Bloomberg see the euro trading at or above $1.40 by year-end. Median estimates put it at $1.36 by June 30 and $1.30 by Dec. 31.
The ECB chief hardened his comments March 13, when he said at an event in Vienna that the currency is “increasingly relevant in our assessment of price stability.” He told reporters at the International Monetary Fund meeting in Washington on April 12 that a stronger euro would require further stimulus, and made his most recent comments in an April 24 speech in Amsterdam.
Europe’s shared currency has been supported by an improving economy and investor appetite for assets in the euro-region periphery. Purchasing managers’ indexes for Spain and Italy and euro-area retail sales data beat economists’ forecasts yesterday, while Spanish 10-year debt yields fell to a record 2.92 percent.
U.S. exchange-traded funds investing in European stocks and bonds attracted $7.4 billion this year through May 5, or 22 percent of their total assets, according to data compiled by Bloomberg. Funds investing in Spain added $1.2 billion, the most among 31 countries outside the U.S.
An official report on April 30 estimated euro-zone consumer prices rose 0.7 percent last month from a year earlier. While that’s up from a 0.5 percent increase in March, it’s below the ECB’s target of just under 2 percent. Only two of 58 economists surveyed by Bloomberg expect policy makers to cut the main refinancing rate from an all-time low of 0.25 percent tomorrow.
An unexpected drop in March German factory orders today helped temper the euro’s gains.
“Data in the euro zone has so far not been conclusive enough to prompt urgent action from the ECB,” James Kwok, the London-based head of currency management at Amundi, which oversees $1 trillion, said by e-mail on April 29. “However, a further acceleration of the euro above $1.40 would build grounds for eventual action.”
Traders are weighing whether Draghi is talking tough on the currency or really plans action to weaken the exchange rate.
“Policy easing at this Thursday’s meeting is certainly more likely than it was, but the ECB’s reluctance to move shouldn’t be underestimated,” Paul Robson, a senior foreign-exchange strategist at RBS in London, said in a May 5 client note, adding that the euro may touch $1.40 as a result. “The language of the post-meeting statement and the tone of the press conference should, however, convey a more dovish policy bias.”
Relative calm in markets is making further ECB action less urgent, according to Ian Stannard, the head of European currency strategy at Morgan Stanley in London.
Implied three-month volatility on the euro-dollar exchange rate fell to 5.55 percent on May 2, the least since July 2007 and about a half-percentage point from the lowest level since the shared currency’s 1999 debut.
When the Swiss National Bank intervened to weaken the franc by imposing a cap of 1.20 per euro in September 2011, anticipated volatility had surged to a record 26.5 percent the previous month, data compiled by Bloomberg show.
“The main problem for the ECB is if they don’t do anything,” Beat Siegenthaler, a currency strategist at UBS AG in Zurich, said yesterday by phone. “Then I would think we’d break the highs of the year, which will mean more pressure for them later on. If we do go above $1.40 it would create a lot of headlines that they could do without.”