ECB Easing: Too Little, Too Late?

While the U.S. dollar has had a stellar run in the past few months, the euro’s forex performance has been an absolute bloodbath. Can we expect more losses for the shared currency?

Just recently, the euro zone printed another set of inflation estimates which revealed that deflation could pose a threat to the region’s already feeble economic growth. The headline CPI flash estimate dropped from 0.4% to 0.3% in September while the core CPI flash estimate declined from 0.9% to 0.7%. That’s way below the ECB’s target of 2% inflation!

euro ecb stimulusThis just means that ECB Governor Draghi and his men must step up their game in order to prevent another euro zone meltdown. As it is, they seemed to have used up almost every monetary policy tool in the shed, as they’ve already cut several interest rates twice this year and implemented targeted long-term refinancing operations. Draghi also hinted that they are planning to purchase asset-backed securities (ABS) in order to boost liquidity, and he is expected to share more details on this in tomorrow’s ECB rate statement.

The size of the ABS purchases might set the tone for the euro’s forex price action, with any figure north of 300 billion EUR likely to push the shared currency much lower against its counterparts. No additional rate cuts are expected for now, although it wouldn’t be surprising if Draghi announces plans to adopt unconventional easing tactics.

Of course the ECB still has the option to implement actual quantitative easing, which would involve purchases of government bonds in a last-ditch effort to jumpstart economic activity. However, this idea is encountering very strong opposition from Germany for now. Besides, Draghi might want to save this measure for more desperate times.

Bear in mind that the euro zone is facing the prospect of even weaker growth, as the sanctions from Russia could weigh on food and energy exports. Declining price levels and bleak wage growth could drag consumer spending lower. Credit conditions could remain anemic, as banks didn’t seem to giddy about the latest targeted LTRO. In other words, the odds are not in the euro zone’s favor!

With that, the euro could stand to lose further ground to currencies whose central banks are moving closer to tightening. For now, it looks like the Fed and the BOE are leading the pack, suggesting that there could be more downside for EUR/USD and EUR/GBP. Do you agree?

  • ForExchange

    I even find the 1.2500 forecast way too optimistics. I think until the end of the year there is enough time to push the pair down about to the 1.2000 levels.

    • Fundamentally yeah I totally agree, but it seems that market sentiment is showing that euro shorts are reaching extreme levels. I’m also eyeing anything south of 1.2500 but I haven’t figured out my time horizon yet, maybe early next year or when the Fed finally hikes rates?

  • When the ECB purchases asset-backed securities, they end up putting more cash in the economy so this increase in money supply should drive the value of the currency lower.

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