On Thursday September 3rd, the EUR-USD exchange rate plunged as much as 1.26% from 1.1233 to 1.1091. Why? The European Central Bank (ECB) just unveiled a revamp of its quantitative easing program.
ECB president Mario Draghi said in Frankfurt that the Governing Council has now raised the purchase limit of any give bond from 25% to 33%. The ECB also lowered its inflation forecast. Moreover, interest rates were left unchanged at record lows.
According to the ECB president, the stimulus package is expected to continue “until the end of September 2016, or beyond, if necessary.”
“The information available indicates a continued, though somewhat weaker, economic recovery and a slower increase in inflation rates compared with earlier expectations,” said Draghi. “Taking into account the most recent developments in oil prices and recent exchange rates, there are downside risks [to the inflation forecast].” (Source: Bloomberg, September 3, 2015.)
The European stock market cheered on the news. The FTSE 100 was up 1.82%, the DAX gained 2.69%, and the CAC 40 surged 2.18%.
The euro, on the other hand, depreciated against the dollar on the ECB’s dovish comments and the region’s uncertain economic outlook. The euro lost as much as 1.26% against the mighty greenback after the ECB’s announcement.
Eurozone Economic Crisis
From a fundamental perspective, the euro is bound for further tumbles against the U.S. dollar.
The reason is simple: the eurozone and the U.S. are on divergent paths in terms of economic growth.
The economy looks rather gloomy in the eurozone. Three months ago, the ECB estimated that gross domestic product (GDP) growth would be 1.5% in 2015, 1.9% in 2016, and two percent in 2017. Now, the central bank lowered these forecasts to 1.4%, 1.7%, and 1.8% respectively.
The U.S., on the other hand, is telling a much more cheerful story. According to the most recent report from the Bureau of Economic Analysis, the real U.S. GDP increased at an annual rate of 3.7% in the second quarter of 2015, much higher than expected. Moreover, the report also revised real GDP growth in the first quarter to a positive 0.6%. (Source: Bureau of Economic Analysis, last accessed September 3, 2015.)
There is hardly any inflation in the eurozone. In August, inflation in the area only edged up 0.2% on a yearly basis, far below the ECB’s target inflation rate of two percent. At the current pace, there is hardly any inflation in the eurozone, and deflation pressure is looming in the distance. This would not be good for the eurozone economy as households and businesses might hold back on their spending in the hope that prices would drop in the future.
In the face of sluggish price levels, the ECB is determined to do whatever it takes to get inflation back to its targeted two percent. This includes further quantitative easing. Right now, the ECB is buying 60 billion euros ($66.7 billion) worth of bonds every month.
The U.S. Federal Reserve’s plan is quite the opposite. Earlier this year, the Fed said that it expected to raise interest rates sometime later this year.
In a word, the underlying economies of the two currencies are on quite different growth paths. The euro might bounce back a little bit in the next few trading sessions, but in the longer term, the EUR-USD exchange rate is doomed to keep falling.