* Market had expected more aggressive talking down of euro
* Tighter liquidity conditions could push currency higher
* Euro/dlr 1-mth risk reversals indicate euro may gain more
* U.S. shutdown and debt worries underpinning euro
By Anirban Nag
LONDON, Oct 7 After what was seen as a lukewarm
protest against a strengthening euro by European Central Bank
chief Mario Draghi last week, financial markets are gunning for
more gains for the single currency.
On the face of it, the bank has done much on actual policy
to lay the ground for a halt in the currency's gains, allying an
extremely cautious view on the euro zone's recovery to a promise
to pump yet more money into the banking system if market
interest rates show even a hint of rising.
But many in financial markets are more interested in the
contrast between President Mario Draghi's line on the currency
last Wednesday and what the bank said when it was last this
strong in February.
Then, the ECB inserted into its statement a clear expression
of concern over the exchange rate's cooling impact on growth and
prices. There was no such line this time - and while Draghi
himself again noted the relationship with growth, there was no
explicit warning that the euro was harming economic activity.
Some strategists believe the bank may be less concerned
about the currency this time round because money market rates
are low - in stark contrast to February, when they were rising.
"At that time, the ECB was fighting the upward trend in
money market rates, which it deems it must control tightly to
foster any sort of durable economic recovery," said Tom
Levinson, currency strategist at ING.
"It is the decline in money market rates in recent weeks
that potentially made (ECB President Mario) Draghi's mind up not
to be more aggressive."
U.S. TIME BOMB
The euro's prospects in general have changed dramatically
since Draghi's landmark statement a year ago that the bank would
do all that was needed to defend the single currency project.
The euro area, driven back into recession by the debt and
banking problems of its southern members, looks set to register
its second quarter running of minimal but solid growth. Worries
over the collapse of Italy's government have receded for now.
Ireland is getting ready to be the first bailed out
government to get back to market financing. Even Greece is
hopeful of emerging from recession.
Add to that in the past week the prospect of a historic U.S.
debt default that would make the single currency a haven for
investors seeking safety for their money away from the dollar.
"The closer we get to this kind of scenario, the more we
would expect the world to divide into a flight to safe haven
currencies, with yen, Swiss franc, the euro, and sterling
preferred in that order," said Alan Ruskin, currency strategist
at Deutsche Bank, adding the euro could hit $1.40.
A surge to those sort of levels, last seen two years ago, is
expected to galvanise the ECB policymakers to intervene
verbally. Some analysts expect the ECB to start jaw boning even
before that given that the euro on a trade-weighted basis
is already at a two-year high.
"We would expect the ECB to speak about the exchange rate
once it is around $1.38 as it does lead to tighter conditions,"
said Manuel Oliveri, FX strategist at Credit Agricole. The bank
has a buy on the euro with a short term target of $1.3830.
A few weeks ago the ECB said it was ready to offer more
long-term loans to banks to keep money-market rates from rising.
Many saw this as a covert attempt to push the euro, which has
gained about 4 percent in the past month, lower.
Euro zone money market rates, in part as a result, are below
February highs. The one-year, one-year forward Eonia rate, one
of the most traded money market instruments which shows where
one-year euro overnight rates are seen in a year's time,
are at 0.35 percent, well below February
highs of 0.475 percent.
One-month euro/dollar risk reversals, a
measure of relative demand for options on a currency rising or
falling, on the other hand are showing a bias for more euro
"The euro has momentum to rise towards $1.37 in the short
term as ECB policy right now is not directed towards the
exchange rate," said Francesco Scotto, portfolio manager at RTFX