LONDON (Reuters) - If the European Central Bank’s latest monetary easing salvo was a surprise in its intensity, then so was the seemingly perverse rise of the euro in response - a move that’s left the most bearish currency forecasters scratching their heads.
The euro rallied to its highest in almost a month against the dollar, surging as much as four cents at one point, confounding those who had bet negative interest rates and billions of euros of extra stimulus would send it lower.
This has echoes of the yen’s surge since the Bank of Japan’s surprise move to negative interest rates on bank deposits in January and raises questions over the effectiveness of central bank stimulus, no matter how aggressive or surprising it may be.
It wasn’t supposed to be this way. A year ago most of the banking world’s major players were calling for the euro to fall to parity or lower against the dollar. The consensus in the latest Reuters poll earlier in March was still for the euro to fall over the coming year.
Negative interest rates and bond yields were supposed to drive the euro zone’s huge savings pool overseas in search of higher returns, thus weakening the euro. Deutsche Bank analysts dubbed this their “euroglut” theory and said the euro could fall to $0.85 by the end of next year.
One explanation for the apparently perverse euro move is that the ECB’s measures on Thursday weren’t aimed at lowering the exchange rate specifically, but at boosting bank lending and getting liquidity flowing through the corporate world.
In theory, this would support growth, economic activity and demand, thereby lifting inflation and inflation expectations. In effect, the transmission of monetary policy would come via the banking system, not from debasing the currency and hoping for an export-led recovery.
That said, a weaker euro would lift imported inflation and counter the deflationary impact of plummeting dollar-based oil and commodity prices. Yet ECB President Mario Draghi steered clear of “talking down” the euro in his press conference and crucially said he didn’t anticipate having to reduce rates further, which the FX market also jumped on.
Goldman Sachs, who along with Deutsche are among the biggest euro bears in the market, said on Friday it was sticking with its call of $0.95 in a year’s time, but noted that a move lower in the near term was less likely.
“In an absolute sense, the ECB delivered an impressive set of easing measures. But life is more complicated than that,” Goldman’s FX strategy team led by Robin Brooks wrote in a note to clients.
Deutsche Bank’s George Saravelos said he and his team would consider their view over the weekend.
The euro rose as high as $1.1215 EUR= in the hours following Draghi's press conference, having initially fallen as low as $1.0820. It was last trading at $1.11, still higher than before the ECB's decision.
In some regards, the bar for severe euro weakness was always high. The euro zone has a balance of payments surplus of 3.7 percent of gross domestic product, meaning the region already has a natural annual net inflow of more than 300 billion euros.
And if conventional economic thinking holds that inflation erodes a currency’s value over time, then the persistence of low inflation or even deflation may well have the opposite effect.
Like Japan, the euro zone’s battle with deflation only makes the euro itself a better store of value absent some collapse of the single currency itself. As aggressive as the ECB’s easing was, Draghi also said inflation will remain low. The ECB’s target of just below 2 percent won’t be met for years.
The other big factor that has undermined the supposed central narrative behind the dollar’s surge early last year is the U.S. Federal Reserve.
If the logic was that a growing gap between official rates on either side of the Atlantic would drive a steady flow of capital into the dollar, then the reeling in this year of expectations for Fed rate rises has also held the euro up.
“The great policy divergence was only going to widen in 2016. But it’s narrowed,” said HSBC’s chief global currency strategist David Bloom, one of the voices most consistently at the other end of the forecast spectrum.
“There’s is no magic in the negative world. Negative rates are everywhere in FX.”
Editing by Mike Dolan/Ruth Pitchford