Euro Weakness Seen Prolonged Even With Another ECB Rate Increase

Currency analysts expect the euro to extend its eight-week slide against the dollar even if the European Central Bank raises interest rates on Thursday to tame inflation.

(Bloomberg) — Currency analysts expect the euro to extend its eight-week slide against the dollar even if the European Central Bank raises interest rates on Thursday to tame inflation. 

Traders see an almost 70% chance that the ECB lifts borrowing costs by a quarter-point on Thursday, after a Reuters report this week said the central bank now expects inflation to stay above 3% next year. 

And yet, analysts have weighed in with the broad expectation that a rate boost would deliver only a brief respite to the common currency. Although the euro has stabilized to start this week, it’s been faltering the past couple months amid signs of weakening growth momentum in the region, which faces another winter of elevated energy costs. 

“We may see some euro strength if the ECB does hike, but we remain bearish on euro against the dollar for the rest of the year on much weaker Eurozone data,” Bank of America strategists wrote in a note on Wednesday. 

The US rate premium over the euro region, stronger growth prospects in the world’s largest economy as well as rising commodity prices that erode Europe’s terms of trade are all working against the common currency, analysts said. 

Read more: Germany to Predict 2023 Contraction as Industry Woes Deepen

A quarter-point ECB rate increase Thursday would take the main refinancing rate to 4.5%. The Federal Reserve, meanwhile, is expected to keep its benchmark rate on hold next week, in a range of 5.25% to 5.5%. 

Lower Forecast

On Wednesday, Citigroup Inc. lowered its 6- to 12-month forecast for the common currency to $1.06 from $1.14 previously. At about $1.07 in New York trading on Wednesday, the euro has slumped from a 2023 closing high of about $1.12 set in July.

“The Eurozone recession now comes before, not after, that of the US,” Citigroup analysts led by Adam Pickett wrote. 

The bank favors the currencies of commodity exporters with exposure to US or China and is underweight European currencies.

On an ECB rate hike, “it’ll be a moment to fade any EUR/USD strength,” Nomura currency strategist Jordan Rochester said in an emailed comment.  

Rochester expects a grind lower in the euro toward $1.05 before year-end. 

“A continued commodity rally could result in levels below that too,” he added. The common currency’s 2023 low is $1.0484, set in January. 

This week, the euro has traded around its 100-week moving average at $1.0740. If it manages to hold above that level, the 200-day moving average at $1.0828 may act as a barrier to an additional advance. The euro had traded above its 200-day average since December, before breaking below it this month.

Here’s what other strategists have to say on the euro’s outlook:

  • The most likely scenario for European policymakers is a hawkish hold that may turn out to be currency-negative, according to Steven Englander at Standard Chartered Bank. A pause may be interpreted as “locking in a long-term rates differential with the US, augmenting the damage to the euro,” he wrote Tuesday.
  • “US exceptionalism will continue into 2024, leaving Fed cuts as the strongest argument for the dollar downside,” wrote Skylar Montgomery Koning and Andrea Cicione at TS Lombard. “But economic divergence is feeding into central bank policy, making it harder to get the dollar weakness.”

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