The European Central Bank (ECB) is having another meeting on Thursday, April 21. How will it affect the euro to dollar exchange rate (EUR/USD)?
This Could Be Bad News for the EUR-USD
Well, to be honest, the tone has already been set. And it’s not the announcement that’s going to affect the EUR to USD exchange rate; it’s the conditions of the two regions’ underlying economies.
The ECB went all out last time, ramping up its stimulus package. In March, it cut its benchmark interest rate to zero percent, cut the marginal lending rate to zero percent, and cut the deposit rate to -0.4%. So, if you were a commercial bank and wanted to deposit money at the ECB, you’d have to pay interest to the central bank. (Source: “ECB Ramps Up Stimulus But Disappoints Markets,” The Wall Street Journal, March 11, 2016.)
Negative interest rate policies (NIRPs) aren’t exactly uncommon these days. Central banks from Japan to Sweden have also adopted negative interest rates. The purpose is simple: by lowering interest rates, central banks want to encourage spending to boost economic growth.
Other than rate cuts, the ECB also increased the scale of its quantitative easing (QE) program last month. Previously, the ECB was purchasing €60.0 billion worth of bonds per month. Now, it’s purchasing €80.0 billion of bonds every month. Moreover, the bank said that it would also buy non-bank corporate debt as part of the program.
Normally, when the central bank lowers interest rates and prints more money, we see prices going up. The idea is simple: when more money is chasing the same basket of goods, each good in the basket is going to command a higher price.
But that’s not what happened. Consumer prices in the eurozone did not increase at all in March. And in February, they actually declined by -0.2%. So instead of seeing inflation, the eurozone economy is facing serious deflationary pressures. (Source: “Euro Area Inflation Rate,” Trading Economics, last accessed April 20, 2016.)
What’s the consequence of deflation? Well, when prices are expected to drop in the future, consumers might want to hold on to their cash today in the hope of buying goods at lower prices in the future.
The implication of deflation goes completely against the ECB’s goal of stimulating the economy. Based on the current situation in Europe, the bank is running out of tools—and that’s a huge bearish catalyst for the euro to dollar exchange rate, especially if you look at what’s going on in the U.S. economy.
In the U.S., job creation has been solid and the economy is growing at a decent pace. On the monetary policy front, the U.S. Federal Reserve has officially lifted off the throttle. Last December, the Fed increased its benchmark interest rate for the first time since 2006.
Another bearish sign for the EUR-USD pair is the uncertainty in Europe. Greece’s problems don’t make the headlines anymore, but there is a much larger economy thinking of leaving the club that is making headlines—the United Kingdom.
To be more precise, the U.K. is thinking about leaving the European Union (EU), not the eurozone, because it was never in it. The country is going to hold a referendum on its membership in the EU. If it chooses to leave, there could be serious consequences, as the U.K. is the union’s second-largest economy by gross domestic product (GDP), falling behind Germany.
Now, before you start selling the euro, note that not everything is bad for the eurozone’s currency. For instance, judging by the retracement of the EUR/USD pair, the euro might have recently found some support against the U.S. dollar.
You see, the EUR to USD exchange rate has been recovering from the huge drop toward the end of last year. During the process, the pair has climbed above the 61.8% retracement level—a key Fibonacci ratio. This month, the EUR to USD pair has dropped to this level but was quick to bounce back. Corresponding to $1.128, the 61.8% retracement level could act as a new support for the euro.
Chart courtesy of www.StockCharts.com
The Bottom Line on the Euro to Dollar Exchange Rate
The euro might not depreciate that quickly against the U.S. dollar due to its newfound support level. But in the long run, fundamentals will play out and the euro to dollar exchange rate could experience another downturn.