EUR-USD Exchange Rate Could Hit Parity, Says Analyst
The euro has lost at least 1.5% to the U.S. dollar, plummeting to 1.1168. The EUR-USD exchange rate dropped in response to news of the decision by the central bank to leave interest rates unchanged. Presumably, the ECB’s continued quantitative easing effort has put more pressure on the Federal Reserve to delay raising interest rates until later in 2016 rather than in December, which is when the next window of opportunity for interest rate decisions will occur.
It might be fair to suggest that the U.S. dollar and the euro are heading towards parity. Indeed, this scenario is realistic and could materialize before the end of 2015. Should the Fed even hint at an interest rate hike, it would trigger a surge in the EUR-USD exchange rate, bringing the American currency to the same level. The fundamentals of the eurozone’s economy do not warrant monetary tightening any time soon.
Euro to Dollar Forecast 2016
There is an actual divergence in the pressures motivating the monetary policies of the Federal Reserve and the European Central Bank. Clearly, the euro will fall more with respect to the dollar even if the euro has shown some resilience in resisting the downward trend. However, the bank’s governor Mario Draghi’s words and the ECB’s steps to confront the persistent deflationary pressure may break the euro’s resistance.
As it happens, Forex market strategists at Deutsche Bank are already proceeding to deal with the imminent euro-dollar parity. (Source: “Weaker Euro to US Dollar Exchange Rate Predicted by Deutsche Bank before 2015 Ends,” ExchangeRates.org, Sept 25, 2015.) They have based this on the expectation of strong capital outflows in Europe and the prospect of a reversal of the Federal Reserve’s accommodating monetary policy in the short term.
The EUR-USD exchange rate suffered sharp declines simultaneously at the press conference by Mario Draghi, in which he seems to have opened the door to another increased quantitative easing for the next meeting in December. Draghi pointed out that the Central Bank remains “ready to act and to use all the tools” as part of its mandate to raise inflation toward the two percent target. (Source: Claire Jones, “ECB opens the door to December stimulus,” Financial Times, Oct. 22, 2015.)
In December, the ECB will deliver monetary stimulus to combat the double threat posed by low inflation and low growth in the eurozone. Draghi made the announcement at the end of the meeting of the Governing Council, presumably to combat downside risks to growth and inflation and problems in some emerging markets.
“We are open to all options for monetary policy,” said Draghi, fueling speculation of further monetary easing. He also hinted that slower Chinese growth prompted the move. (Source: Paul Hannon and Todd Buell, “ECB’s Draghi Sets December for Stimulus Review,” The Wall Street Journal, Oct. 22, 2015.)
Markets React Favorably to ECB’s Continued Quantitative Easing
The markets reacted with euphoria to Draghi’s words. His speech prompted a buying wave in all European markets. The DAX jumped to 2.46%; the CAC index in Paris grew 2.45%; while London (as the campaign to break the U.K. away from the European Union) gained 0.47. Wall Street also reacted well with the Dow up 1.07%; the S&P 500 up 1.03%; and the NASDAQ up 1.07%.
Draghi and the ECB have therefore sent a clear message to the markets. In December, the ECB will adopt new expansionary measures to include either a stepping up of quantitative easing (currently the ECB buys 60 billion euros in securities a month, mostly government bonds), an additional interest rate cut on bank deposits with the ECB, or a combination of both. (Source: Jenny Cosgrave, “ECB ups growth forecasts; will start QE on March 9,” CNBC, March 5, 2015.)
The ECB’s decision, however, suggests lower-than-expected growth in the eurozone. Central bankers are worried about what appears to be the elusive goal of bringing inflation back up to two percent; which is part of their mandate. Some governors said that Draghi showing the extent of concern over the missed inflation targets (a sign of low growth) had actually urged adopting some of the new measures today. Presumably, Draghi worried that acting with such urgency would have caused a sharper drop between the U.S. Dollar and the euro.
Chart courtesy of www.StockCharts.com
The ECB’s acquisition of security as part of its quantitative easing measures, as Draghi said in September, has “been progressing smoothly, having a favorable impact on the availability of credit for households and businesses.” (Source: “Mario Draghi, President of the ECB, Vítor Constâncio, Vice-President of the ECB, Frankfurt am Main,” European Central Bank, September 3, 2015.) The ECB started its massive purchase plan last March. As of last October 16th, it held $371 billion of government bonds in its portfolio.
At their meeting in Malta today, the European central bankers left the main refinancing rate at a record low of 0.05%. The marginal lending rate and the rate on bank deposits are respectively 0.30% and -0.20%. Nevertheless, these could soon drop even further.
The ECB has sent a clear message that it will take an aggressive position in the markets to counter deflationary pressures. In September, consumer prices in the eurozone showed a negative trend (-0.1% on year). If inflation continues to remain so low, the ECB may decide to extend the scope of the purchase program of private and public assets by 60 billion euros per month.
QE was launched in March to help restore the rate towards the goal of an annual increase below but close to two percent, as per the mandate of the ECB. Inflation has risen since the September bottom but remains far from the elusive two percent. Draghi and the ECB have sent a clear message that they fear inflation will remain very low in the short term.
Here’s the Bottom Line on the EUR-USD Exchange Rate
In their prediction that the euro and the U.S. dollar are heading for parity, Deutsche Bank notes that the outflow of European capital will significantly influence the euro-dollar exchange. (Source: Rachel Evans, “ECB May See More Capital Outflows Than Bargained for With QE,” Bloomberg, Mar. 5, 2015.) As for the Fed, the analysts believe that its reinvestment policy is of greater concern than the mere timing of the rise in interest rates. Nearly half a trillion dollars of the Fed’s budget will mature in 2016, almost the equivalent of a quantitative easing program in reverse.
The Federal Reserve’s access to dollars has a strong impact on the Deutsche Bank’s forecasts over the euro-dollar exchange. The ECB’s decision to extend QE in an effort to raise inflation will add further impetus for the dollar and the euro to move in opposing directions and reach parity. Perhaps even as early as the end of 2015, as Deutsche Bank has predicted. I’m inclined to agree.
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