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Why Euro's Getting Slammed Despite Central Bank Easing

Thursday, 5 Jul 2012 | 2:27 PM ET

Despite a round of global central bank easing, the euro skidded and could soon test its lows of the year, after Europe’s top banker painted a bleak picture of the region's economy.

The European Central Bank cut rates by a quarter point, as expected, and the Bank of England moved forward with more quantitative easing. In a surprise move, the People's Bank of China joined in Thursday, moving forward with surprise rate cuts at about the same time as the Bank of England news.

Yet, sentiment soured as ECB President Mario Draghi said euro-zone growth is weakening and there’s materializing downside risks to growth.

He also said the ECB’s bond buying program and other extraordinary measures are temporary, forewarning a market that wanted to hear about more liquidity not an end to the current programs.

The ECB cut its main interest rate by a quarter point to a record low of 0.75 percent and cut the deposit rate by a quarter, to a level of zero, in an effort to encourage lending.

The euro fellas low as 1.236 after Draghi’s comments and was down more than a percent at midday. The dollar index gained 1.3 percent.

Brown Brothers Harriman chief currency strategist Marc Chandler said one factor that hasn’t gotten a lot of attention but could be impacting the market is an ECB collateral rule change, released Tuesday afternoon. Lower rates also typically means weaker currency, as traders adjust portfolios.

Sorting Out Mixed Market Signals
The ECB and China have both cut their key interest rates overnight, but Mark Mobius of Templeton Emerging Markets Group has optimism for Europe. Kenny Polcari of ICAP, offers insight.

“The collateral change means it’s going to cost the sovereigns more money to support their banks,” he said. The ECB said it would cap current levels of the amount of government guaranteed debt banks can use as collateral on loans though it would make exceptions in certain cases, and those banks would need acceptable funding plans.

Chandler said that could be a reason for the snap higher in Italian and Spanish bond yields Thursday.

“The euro has given back all the post-summit gains,” Chandler said, referring to last week’s EU summit. “It’s not just the euro, it but it’s Spanish bonds, Italian bonds.

Boris Schlossberg of BK Asset Management said he thinks the market was hoping for more from the ECB. “The problem is it’s the only agency in the euro-zone theater that’s able to act unilaterally,” Schlossberg said. “The fact it’s not doing so creates this state of siege in the euro-zone market. The euro here is clearly testing its year-to-date low. It’s at a critical juncture. Tomorrow’s nonfarm payrollsis going to be pretty important.”

“If we do have positive data tomorrow, the Australian dollar will by far be the currency to respond to that positive data,” he said. “If there’s going to be a beneficiary of the risk trade, it’s going to be the Australian dollar.” Schlossberg, BK managing director, noted the Australian central bank stopped its rate-cutting strategy at this point.

The euro fell to record lows against the Australian dollar Thursday. Schlossberg said the interest in the Australian dollar may also be because some traders are using it in the carry trade, or a financing vehicle for leverage to trade other assets.

Schlossberg said the euro could retest its 2012 low against the U.S. dollar, of about 1.228 if the June jobs data is poor.

The collateral rule change by the ECB sends markets the wrong message at a difficult time, Schlossberg said. “They’re not seeing any dramatic action from policymakers, and what they’re seeing is the European economy continues to stagnate and decline,” he said.

Follow Patti Domm on Twitter: @pattidomm

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

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  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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