Investors bought firmly into the view that a diverging outlook for interest rates is the key driver for the euro in the wake of the European Central Bank’s extension of quantitative easing, leaving the single currency nursing its biggest one-day drop against the dollar since the UK’s vote to leave the EU.
After a knee-jerk 1 per cent leap up in the euro as headlines flashed that the ECB was reducing its monthly bond buying from €80bn, traders and investors quickly sold the currency to leave it down 1.3 per cent at $1.0605 in late trading in London.
Mario Draghi, ECB president, was at pains to stress that the cut in purchases to €60bn a month from April did not constitute a tapering of its quantitative easing programme given that the central bank would continue buying bonds until the end of the year.
The euro’s about-turn in price action was set in motion “as everyone realised it was a bigger QE extension than anticipated”, said Brad Bechtel of Jefferies International.
The ECB extended its QE programme by nine months, three months longer than expected.
Mr Draghi’s pledge helped push out the spread in yields between two-year Treasury and German Bunds by 10 basis points. The moves in the spread and the euro showed that rate divergence was “on the agenda”, said Jane Foley, Rabobank’s G10 FX strategist.
That shift in the purchase programme was “a bit of a stick in the eye for the camp that [believed] monetary policy was effectively dead around the world and the central banks were passing the torch back to the politicians”, Mr Bechtel said. “This is ECB retaking control and maintaining its dominance in the European markets.”
Attention will now turn to US Federal Reserve policymakers who meet next week and are expected to raise interest rates, adding to their first move a year ago.
Thursday’s drop in the euro comes after a November dominated by a resurgent dollar, which has been led higher by expectations the central bank will be forced to raise rates further next year as growth heats up and inflation rises.
“The next phase is what the Fed will signal for 2017,” said Ms Foley. She believes the Fed would not want to raise more than once next year. “It will want to avoid the sharp move in the dollar in 2014 which moved aggressively in expectation of aggressive rate tightening.”
The euro is 3.8 per cent lower against the dollar since US election day, and is expected to fall further, with European political risk an increasing concern for investors.
“Last weekend’s Italian referendum result was a timely reminder that political tensions within the eurozone remain acute and threaten the upbeat tone to recent European data and the stability of the financial sector, “ said Tim Graf, head of European macro strategy at State Street Global Markets. “The euro looks likely to test recent lows once more.”