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Does euro's plunge mean the bulls have been too hasty?

Roll of euro bank notes
Martin Diebel | Getty Images
Roll of euro bank notes

Halloween proved to be a scream for the euro, which saw its steepest one-day decline in 16 months Thursday - a move some analysts say suggests recovery hopes could have been premature.

Sean Callow, senior currency strategist at Westpac, told CNBC he was surprised by the steepness of the euro's fall. "There is a lot of talk about a recovery in the euro zone... which is definitely premature in our book. This move is a reminder that European officials face very serious challenges," he said.

A slew of weaker-than-expected data out of the euro zone Thursday, combined with Wednesday's less-dovish-than-expected Federal Reserve comments and dovish comments from European Central Bank (ECB) member Ewald Nowotny on Thursday, triggered the selloff.

(Read more: 'Double whammy' pushes euro to two-week low)

Euro zone inflation fell to a four year low of 0.7 percent in October, year-on-year, from 1.1 percent in September, while unemployment remained at a record high of 12.2 percent. The data saw the euro tumble near 1.2 percent against the U.S. dollar Thursday and an additional 0.3 percent in early Asian trade Friday. It was recently at $1.3556.

(Read more: Euro zone not yet fixed: JP Morgan's Dimon )

Meanwhile, a slightly more dovish statement from the Federal Reserve suggested tapering could come sooner than expected, which strengthened the greenback and further pressured the euro.

The data marked a sharp contrast to more positive news out of the currency bloc earlier this year, when gross domestic product expanded 0.3 percent in the second quarter, lifting the region out of recession and prompting hopes of a recovery.

Callow said the inflation data was the main trigger for euro selloff, because it led many investors to start pricing in potential easing from the central bank. The 0.7 percent figure is well below the ECB's target of close to 2 percent.

"The ECB may be able to brush off a rise in unemployment, but it always insists that the one thing it is able to control is inflation, so it cannot ignore this," he said, adding that he expected the currency to weaken further to around $1.34 on a one month view as the central bank takes a more dovish tone.

(Read more: Why the euro area remains a good investment bet)

Other analysts were also caught off guard by the dramatic fall in the currency.

"The magnitude of the reaction in the euro/dollar suggests that investors have been caught wrong footed as they had expected the ECB to be less dovish and the [Federal Reserve] more so," said Kathy Lien, managing director at BK Asset Management.

On Thursday ECB governor Nowotny told CNBC the bank would provide more liquidity to avoid a "cliff" effect once the bank's cheap loans to euro zone banks come to an end.

(Read more: Euro zone suffers from integration fatigue)

Lien said expectations for a more dovish tone from the ECB would continue to push the currency lower in the near term.

"The mere prospect of easier monetary policy from the ECB could still drive the euro/dollar lower. With support at $1.36 broken, the next level to watch in the euro/dollar will be $1.3475," she added.

While there will likely be much speculation over whether the ECB will take action at next week's meeting, Westpac's Callow said he doubted the bank would react quickly to the inflation data, noting a December rate cut was more likely.

(Read more: Euro zone moving from economic to political crisis)

However, according to Mitul Kotecha, head of global markets research for Asia at Credit Agricole, the euro's plunge was not reflective of any changes to Europe's growth outlook.

"Risks to the euro have been building for some time... The bottom line is that it was primed for a fall," he said.

"It's more of a case that the euro has built in too much good news, and on top of that it's been benefiting from a weaker dollar and the delay of tapering...I don't think there's been a change in the perception of Europe's growth story. Data has generally been positive, aside from a few disappointments," he added.

Kotecha pointed out that a weaker euro will in fact benefit Europe's growth outlook because it will make its exports more competitive.

—By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie

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