Dollar's 7-Month High Reflects Fed, ECB Policy Split on Horizon

  • Goldman Sachs sees rally continuing up to ECB's Dec. 3 meeting
  • U.S. Fed moves closer to December rate increase, futures show

The dollar rose to a seven-month high against the euro as speculation mounted that the European Central Bank is prepared to provide more monetary stimulus to revive inflation, diverging from the Federal Reserve’s plan to raise interest rates.

The U.S. currency strengthened as reports showed Wednesday orders for business equipment climbed more than forecast and purchases of new homes rebounded in October, setting the stage for the central bank to potentially raise interest rates on Dec. 16 for the first time since 2006.  Goldman Sachs Group Inc. says the rally may continue up to the ECB’s Dec. 3 meeting.

Higher U.S. rates enhance the allure of the greenback versus the 19-nation currency. ECB policy makers including President Mario Draghi have said they will do whatever is required to ward off deflation.

"The focus is still on the ECB as the dovish rhetoric continues -- the expectations for next week’s meeting is reaching fever pitch levels," said Peter Dragicevich, a foreign-exchange strategist at Commonwealth Bank of Australia in London. "The U.S. economy should remain on a firm footing. We’re expecting the Fed to move in December, the market is still a little underpriced from that perspective" in terms of euro-dollar exchange rates.

The dollar rose 0.2 percent to $1.0624 against the euro at 5 p.m. New York time, approaching $1.0458, a level reached on March 16 that was the strongest since January 2003. The U.S. currency added 0.2 percent to 122.74 yen on Wednesday.

U.S. financial markets will be closed Thursday for the Thanksgiving holiday.

Deposit Rate

Inflation is "very low" and the ECB wants to "ensure price stability in both directions,” Vice President Vitor Constancio said in an interview on Bloomberg TV. The ECB also warned Wednesday of a rapid repricing of global risk premia, focused on emerging markets, especially if the Fed increases interest rates faster than forecast.

“Highly indebted foreign-currency borrowers may be vulnerable to a prospective normalization of financial conditions in the U.S. and other advanced economies,” the ECB said in its twice-yearly Financial Stability Review.

Futures traders see a 74 percent chance that the U.S. central bank will raise interest rates next month. The calculation assumes the effective fed funds rate averages 0.375 percent after the first increase, compared with the current zero-to-0.25 percent target range.

The dollar’s 7.6 percent rally since Oct. 15 still hasn’t fully reflected the divergence in monetary policies, according to Goldman Sachs. The U.S. currency may rally to $1.05 versus the euro before the Dec. 3 ECB meeting, and to parity by the end of the year, according to Robin Brooks, Goldman Sachs’s New York-based chief currency strategist.

"The hurdle is low for a dovish surprise on Dec. 3," Brooks wrote in a research note.

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