Euro surges to fresh three year high despite ECB’s currency warning

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The Euro rallied to a fresh three year high above the 1.25 level against the US Dollar on Thursday afternoon following the European Central Bank’s (ECB) first monetary policy meeting of 2018 (Figure 1).

Figure 1: EUR/USD & EUR/GBP (25/01/2018)

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Source: Thomson Reuters Datastream Date: 25/01/2018

Despite voicing discomfort over the recent sharp appreciation in the Euro, a relatively more upbeat assessment of the Eurozone economy from President of the ECB Mario Draghi was enough to send the currency almost one percent higher for the day. Speaking after the central bank had announced it was leaving its policy unchanged this month, Draghi stoked further speculation that the ECB could bring its quantitative easing programme to an end in 2018. He voiced optimism over the recovery, claiming that the Euro-area economy had expanded at a faster-than-expected and ‘robust’ pace. While inflation was yet to show convincing signs of an uptrend according to the Governing Council, there was also growing confidence that it would return to target.

Investors largely overlooked Draghi’s attempts to quell the latest rally in the Euro. Draghi explicitly mentioned the strength of the currency during his opening remarks of the press conference, reviving a warning on exchange rate volatility not used since September. He stated that ‘recent volatility in the exchange rate represents a source of uncertainty which requires monitoring’.

A warning that rates would not be raised any time soon also failed to halt the Euro in its tracks. As we have been saying for a number of months we do not believe that economic conditions, namely the weak inflationary environment, warrants the need for higher interest rates in the Eurozone this year. This opinion was shared by Draghi, who made it clear he does not anticipate the need for higher rates in 2018, saying he saw ‘very few chances that interest rates could be raised at all this year’. Given these comments, the magnitude of the Euro’s appreciation today is surprising and, in our view, somewhat overdone.

Today’s assessment from the ECB does little to change our opinion that the bank will likely end its quantitative easing programme at the current end date in September. Yet, with core inflation in the Euro-area still stuck below 1%, and with Draghi seemingly in little rush to begin raising rates, we think the first interest rate hike since 2011 is unlikely until mid-2019. This is currently later than the market is pricing in.

We are still of the opinion that the widening in interest rate differentials with that of the US and Eurozone will pressure the already overbought Euro lower in the coming months, particularly considering the stretched net positioning. However, given the current dour sentiment towards the US Dollar and recent sharp appreciation in the common currency we will soon be raising, at the very least, our short term EUR/USD forecasts higher.

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