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Draghi Incapable of Weakening Euro, May Breach $1.50, Merk Says

June 5 (Bloomberg) -- European Central Bank President Mario Draghi will be unable to weaken the euro despite expectations he will unveil a package of stimulus measures designed to do just that today, according to Merk Investments LLC.

ECB officials will cut the benchmark interest rate and set a negative deposit rate for the first time, analysts forecast in separate Bloomberg surveys. While a negative rate will only have a limited impact on the shared currency, policy makers may also introduce another longer-term refinancing operation to counter an involuntary reduction in liquidity, said Axel Merk, president and founder of the Palo Alto, California-based money manager.

“Structurally, it’s just very difficult” to weaken the euro, Merk said in an interview on Bloomberg Television’s “Countdown” with Mark Barton. “He can raise his finger, he can threaten the market with more action -- well, how much more shall we be surprised? Everybody expects Draghi to do a lot and this is how weak the euro is getting.”

Implied volatility on one-day options on the euro-dollar exchange rate surged to the highest level since February 2013 amid expectations policy makers will act to stoke inflation that is less than half the ECB’s 2 percent goal. Slowing consumer-price increases indicate the euro area’s first flourishes of recovery are already on the wane, with data showing industrial output and business confidence dropping in Germany, the region’s biggest economy, adding to the grim picture.

Euro Forecast

The euro was little changed at $1.3608 at 9:47 a.m. London time, down from a 2 1/2-year high of $1.3993 on May 8. The shared currency may strengthen past $1.50 by year-end, Merk said.

The Merk Absolute Return Currency Fund returned 1.6 percent in the past year, outperforming 89 percent of its peers.

“The path of least resistance should be upward in the medium term,” he said. “Draghi is furious that the euro is as strong as it is. That’s why last month he spent a great deal of time talking down the euro. Once he strikes a tad more of an optimistic tone I think the market is going to call his bluff in that he is just not capable of weakening the euro.”

Draghi said last month that the Governing Council was “comfortable” acting in June to dampen the euro and combat low inflation. Two euro-area central-bank officials said Draghi will probably signal any interest-rate cut this week won’t be the last. He may reiterate his commitment to keeping borrowing costs at current or lower levels, they said, asking not to be identified because the talks aren’t public.

“The pure fact of the matter is the banking system is the transmission system and banks are not lending because on the one hand there isn’t enough demand, on the other hand of course the banks still need to repair their balance sheets,” Merk said. “Old projects are not getting refinanced and nothing that Draghi does is going to change that.”

To contact the reporter on this story: Eshe Nelson in London at enelson32@bloomberg.net

To contact the editors responsible for this story: Paul Dobson at pdobson2@bloomberg.net Mark McCord, Keith Jenkins

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