Euro May Exceed $1.40 as ECB Reduces Balance Sheet, Merk Says

The euro may exceed $1.40 “well before” the end of 2013 as the European Central Bank shrinks its balance sheet while other central banks expand theirs, according to Axel Merk of Merk Investments LLC.

The shared currency has appreciated as banks have made early repayments of the first tranche of ECB loans taken under so-called Longer Term Refinancing Operations a year ago, said Merk, founder and president of Palo Alto, California-based Merk Investments. This has come amid signals the euro region’s economy is improving, he said.

“We can breach $1.40 without there being a particularly euphoric interpretation of what’s happening in the euro zone,” Merk said in a telephone interview. “This is all just part of a normalization process. The key difference between the ECB and other central banks is that rather than printing money to boost economic growth, the ECB has a demand-driven balance sheet.”

The objective of Merk’s $553 million Hard Currency Fund is to protect against the depreciation of the U.S. dollar relative to other currencies. The fund has gained 1.68 percent in the past year, ranking it in the 80th percentile versus its peers, according to data compiled by Bloomberg.

The 17-nation currency rose 0.5 percent to $1.3584 at 1:05 p.m. in New York, after reaching $1.3711 on Feb. 1, the strongest level since November 2011. The euro has gained 2.9 percent versus the greenback this year, making it the third-best performer among the greenback’s 16 most-traded counterparts.

Fed, Japan

The Federal Reserve said last week it will continue to purchase $85 billion of Treasury and mortgage debt each month to spur growth and lower unemployment in the U.S. Japanese Prime Minister Shinzo Abe’s administration took office in December on a platform of greater monetary stimulus and a reversal of yen strength that has hurt export competitiveness.

The ECB meets Feb. 7.

An increase by the euro past $1.40 may be challenged by investors selling the euro to take profits on gains, Merk wrote today in a client note.

The premium for one-year options granting the right to sell the euro against the dollar relative to those allowing for purchases reached 0.98 percentage point on Feb. 1, the least since November 2009, based on closing prices compiled by Bloomberg. That’s down from a 2012 high of 3.96 percentage points on May 23, the 25-delta risk reversal rate shows.

“The drivers for the euro to be substantially higher are firmly in place,” Merk said. “$1.40 is just a short-term step that the euro will be taking.”

An index based on a survey of purchasing managers in the services industries of the 17 countries that use the euro rose to 48.6 in January from 47.8 in December, Markit Economics said in a report today. The London-based research company had initially estimated a reading of 48.3 for the measure. A reading below 50 signals contraction.

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