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Euro Bears See Redemption as Draghi Squashes Inconvenient Rally

  • Currency falls to two-week low as ECB widens scope of QE plans
  • Central bank lowers forecasts for growth and inflation

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 Thursday 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. An analyst at Bank of Tokyo-Mitsubishi UFJ Ltd. reiterated his projection for the 19-nation currency to 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 3 percent 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.

The euro rebounded 0.3 percent Friday to $1.1153 as of 9:15 a.m. London time, after dropping as much as 1.3 percent on Thursday to $1.1087, the weakest since Aug. 19. The shared currency declined 0.6 percent to 132.77 yen.

Signs that the euro will weaken further are returning. Investors boosted the premium for options protecting against a decline by the shared currency on Thursday, 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.

Stimulus Plan

Until recently, the ECB’s stimulus, which included a 60-billion-euro ($67 billion) monthly bond-buying program, had helped depress the euro. Between December and July, the currency weakened more than 9 percent 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 1.6 percent.

“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 0.2 percent in July from a year earlier against the ECB’s target of close to 2 percent. 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.

Price Pressure

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.

“Many central banks have been keen to talk down their currencies while maintaining that is not a policy objective,” said Michael Ingram, a market strategist at BGC Partners in London. “The ECB is no exception to this. Foreign-exchange devaluation is one of the few reliable reflation levers that policy makers have open to them.”

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