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Categorized | Currencies, Economy

Euro tumbles on ECB rate cut speculation

Posted on October 31, 2013

A tram passes the giant Euro symbol outside the headquarters of the European Central Bank (ECB)©Getty

The euro fell sharply on Thursday after data showing eurozone inflation at its weakest in nearly 4 years prompted speculation that the European Central Bank could soon take action to avert the risk of Japan-style deflation.

The euro has been one of the strongest major currencies this year, supported by a hefty current account surplus, a resumption of capital inflows to equity markets and a broader perception that its long-term survival is no longer in doubt.

    It has also regained a role as a haven currency as uncertainty over US monetary policy and aggressive monetary easing in Japan reduced the attractions of the dollar and yen.

    Even after Thursday’s fall of 1 per cent to $1.3595 against the dollar, it has gained almost 5 per cent against the US currency in the past year – a move that is proving painful for many eurozone exporters.

    However, October’s inflation print of 0.7 per cent, coupled with data showing unemployment stuck at a record high, will increase the pressure on ECB policy makers to discuss a further cut in interest rates when they meet next week.

    Although they have said they do not see the euro’s recent appreciation as a concern, the currency’s strength is a further factor that will limit inflation.

    “We do not expect a monetary policy move at the next meeting as it can be argued that the internal devaluation is part of the necessary process of correction of imbalances . . . Nonetheless, it is to be expected that President Mario Draghi will in all likelihood be grilled on the deflation threats at the next press conference,” wrote François Cabau, economist at Barclays.

    “The print will fuel expectations of a rate cut next week and a dovish statement,” said Valentin Marinov, strategist at Citi, adding: “The ECB president could highlight the link between currency appreciation and eurozone disinflation.”

    Many analysts think the euro is now vulnerable to a change in market sentiment, since currency speculators had placed heavy bets on its rise that they might now unwind.

    Steven Saywell, strategist at BNP Paribas, argues that the market had underpriced the risk of the ECB cutting rates in December, leaving “substantial scope” for the euro to weaken over the next few weeks.

    Ian Stannard, analyst at Morgan Stanley, said portfolio inflows that had supported the single currency in recent months could also slacken, since valuations of European equities no longer looked as attractive.

    Mr Marinov argued that the effect of a strong euro on corporate earnings could itself deter future demand for European assets, saying: “Given the importance of equity inflows for the euro outperformance, we suspect that evidence that these flows are abating could add to the headwinds for the single currency across the board.”

    The euro also weakened sharply against sterling, falling 1.1 per cent to trade at £0.8473.