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Weaker Euro Could Be in Store as Officials Struggle With Debt Crisis

As expected, the European Central Bank stepped back from its rate hiking cycle, removing one plank from the floor under the euro.

Euro bills and coins
AP
Euro bills and coins

The euro softened on the news, and as the ECB Thursday also downgraded its view of the euro zone economy. But some analysts believe the euro may already be in for a soggy period, as Europe grapples with its peripheral sovereign debtconcerns, and it could be heading to a new lower trading range.

The ECB move also kicked up immediate speculation that ECB President Jean-Claude Trichet's successor, Italy's Mario Draghi, will immediately slice the 1.5 percent benchmark rate when he takes the helm at the November ECB meeting, but some strategists downplayed the talk.

"I can't remember any central banker cutting at their first meeting...I can't see that," said Geoffrey Kendrick of Nomura.

Nomura currency strategists Thursday released a new report, forecasting the euro would trade at 1.30 against the dollar at year-end, from a previous forecast of 1.40. The euro was at 1.3879 at its low point of the day Thursday, and was trading on both sides of the psychologically important 1.40 level.

"Importantly for our (euro) forecasts, even in our base case where Greece avoids a disorderly default, size constraints on the (European Financial Stability Facility) would contribute to a continuation of peripheral concerns, hence (euro) pressures would remain. At the same time we are not proponents of the Fed (third round of quantitative easing) mantra, which should be (dollar) supportive. As a result, we now forecast (euro/dollar) at 1.30 by year end, but we expect this move to be relatively orderly," Nomura strategists wrote in their note.

The euro this week closed below its 200-day moving average for the first time since January. The 200-day is 1.4025 and the move is seen as a precursor to more downside. "The 200-day moving average has been a reasonable guide," said Kendrick.

Win Thin, Brown Brothers Harriman senior currency strategist, said the next target traders are watching is the 1.3837 level, which was the low in early July.

"The euro is still going to get dictated less by comments from Trichet and more by events like what happens to European bank stocks and liquidity and capital issues, and what happens to the Italian bond market, and how do the Greek Troika (IMF/EU/ECB) discussions go. A whole lot of issues that will come to a head into October. There are a variety of important dates coming up. If there are euro negatives, one would look for fresh news on these kinds of issues," said Alan Ruskin, Deutsche Bank head of group of 10 nations currency strategy.

Ruskin believes much is priced in, but if there was a negative development the euro could slide below 1.30. He sees the top of the range at 1.45. He said a critical juncture will come when the ECB hands off purchases of Italian and Spanish debt to the enhanced European Financial Stability Facility (EFSF). Enhanced powers for the 400 billion euro ($555.4 billion) EFSF are to be voted on by euro zone member countries in the next several weeks.

Greece's economy minister Michalis Chrysochoidis was quoted by a German newspaper as saying he expects the "Troika" mission of lenders to grant the next tranche of aid even though the 2011 Greek budget deficit will be wider than the amount agreed with international creditors. Greece is missing the targets it agreed under the 100 billion euro ($138.8 billion) bailout plan agreed in May 2010.

Jean-Claude Juncker, head of euro zone finance ministers, said Thursday that there can be no flexibility for Greece on its budget targets if it hopes to receive the next tranche of its bailout from the EU and IMF. Greece is due to receive 8 billion euros ($11.1 billion) and officials say it will run out of money within weeks if it does not receive the aid.

"Certainly there's no scope for it (the euro) to rally in the face of so many potential pitfalls related to periphery issues. I think the sell euro/dollars mentality makes a lot of sense on upticks. I don't think it's going to run away to the downside because the positioning is already there," said Ruskin.

Questions? Comments? Email us at marketinsider@cnbc.com

  • Patti Domm

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