Talk of more QE is just plain bad for the euro


There's growing talk that the European Central Bank is likely to have to prolong its monetary stimulus programs to lift inflation and growth in the euro area. And it's not doing the euro any good.

The single currency tumbled to a one-month low against sterling on Tuesday and has shed 2.5 percent of its value against the dollar since hitting a three-week high on Friday. It was last trading at about $1.113.

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The renewed fall in the euro comes amid speculation that the ECB will keep its massive bond-buying program in place for longer than originally anticipated. Meanwhile the U.S. Federal Reserve looks likely to raise interest rates in the months ahead even after keeping rates at a record low last week.

"Between Friday and Monday, euro/dollar dropped close to 300 pips and there's a very good chance that this week, we will see a deeper slide in the currency," Kathy Lien, managing director of FX strategy for BK Asset Management, said in a note late Monday.

"Over the past month there has been an extremely consistent message coming out of the European Central Bank. Policymakers expressed their unified frustration with the region's fragile recovery, low level of inflation and global market uncertainty," she said.

One example of the ECB's "consistent message" was a remark made by ECB Governing Council member Ewald Nowotny Monday on how ECB rates would stay low as long as growth did.

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How low?

In a note dated September 20, Goldman Sachs meanwhile said the euro could fall up to 10 U.S. cents as the ECB considers extending its stimulus program.

The central bank is in the midst of buying 60 billion euros ($67 billion) worth of assets a month in a bid to boost inflation and growth in the 19-member euro zone. The program is due to end in September 2016.

Goldman, however, thinks the ECB will continue the program through the end of next year and only end it in mid-2017.

Monetary stimulus tends to weaken a currency, while the prospects of higher interest rates tend to draw foreign cash into a country – hence the prospect of monetary tightening in the U.S. and U.K. has lifted the dollar and sterling this year.

The Bank of England is expected to follow the Fed in a rate hiking cycle.

On the flip side, a weaker currency lifts the price of imports and helps reflate an economy as well as give exporters an edge in overseas markets.

Mind the (rate) gap

"Essentially the interest-rate differential theme is still there, with talk of more QE from the ECB reinstating that argument," Jane Foley, a senior currency strategist at Rabobank, told CNBC.

Rabobank's 12-month view on the euro falling to $1.05 remained unchanged, Foley said.

But she added that a fall in the risk appetite seen at the start of the year that had encouraged investors to use the euro as a funding currency for riskier trades had declined and this should prevent the euro from falling too far.

"We don't expect the euro to fall to parity against the dollar," Foley said.

Still, analysts added that bearish sentiment towards the euro, which has declined 7.5 percent so far this year, was reasserting itself.

"Euro/dollar was net sold for the first time in over a month, with asset managers leading the selling," UBS currency strategist Geoffrey Yu said in a note on Monday assessing flows in the currency markets.