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Euro sees a roller-coaster ride post-Draghi as dollar bulls start to throw in the towel

The currency markets experienced some major moves this week as politics and central banks come front and center, causing one major banking institution to ditch its parity call on the euro and the dollar.

Euro currency banknotes
Alessia Pierdomenico | Bloomberg | Getty Images
Euro currency banknotes

Deutsche Bank on Wednesday morning abandoned calls for the dollar to rise towards parity with the euro. In a research note to its clients, Deutsche Bank revised its EUR/USD outlook to $1.16 or higher by the end of this year from a previous $1.03.

"Our main message is that the euro is likely to be the key vehicle via which financial conditions in the euro area will be tightened," Deutsche Bank's FX Strategist George Saravelos said in the research note.

This comes after the single currency jumped to a nine-day high against the dollar in Tuesday's trade and extended gains as ECB (European Central Bank) President Mario Draghi addressed speculation around the unwinding of its asset-purchase program. Addressing the audience at the ECB forum in Sintra on Tuesday, Draghi said any change in the ECB's policy would be gradual as the euro zone economy still needs monetary support.

"A constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments – not in order to tighten the policy stance but to keep it broadly unchanged," Draghi said.

The hawkish tone saw the euro surging against a number of currencies. While it hit a year-high against the dollar, the single currency jumped to a seven-month high against sterling. The euro was trading at $1.1334 against the dollar at 2:00 p.m. London time. While the current move in the euro is attributed to the comments made by Draghi, a number of analysts point to the monetary policy divergence between the U.S. Federal Reserve and the ECB as a reason for the currency pair's move.

Jock Fistick | Bloomberg via Getty Images

Euro drops to $1.1320

However, sources familiar with Draghi's thinking told Reuters on Wednesday that the ECB chief intended to signal tolerance for a period of weaker inflation, not an imminent policy tightening.

The sources also told Reuters that financial markets failed to take note of caveats in Draghi's speech that were intended to prepare markets for a decision on stimulus later this year without making a firm commitment.

As the news broke on Wednesday afternoon, the euro fell aggressively by 30 percentage points to trade around $1.129.

President Donald Trump.
Cheriss May | NurPhoto | Getty Images
President Donald Trump.

Trump disappointment

Meanwhile, Lina Fransson, a fixed-income strategist at SEB, told CNBC via email – before the sharp drop in the euro – that she expects the dollar to continue weakening against the euro.

"The U.S. dollar has weakened in the last couple of months and this morning, it reached its weakest level against the euro and the krona since last summer/autumn (fall). EUR/USD now trades around $1.1350 while USD/SEK is around $8.60," Fransson said.

She, however, explained that a widespread disappointment of the Donald Trump administration and its lack of action in terms of economic reforms and tax cuts is one reason for the weaker dollar, and yesterday the IMF (International Monetary Fund) lowered its U.S. growth forecast saying that the prospects for fiscal stimulus have faded.

"At the same time, the euro zone is painting a brighter picture and growth has surprised on the upside since the end of last year. Yesterday, the ECB's Mario Draghi delivered a message of increased confidence in the prospect of growth and inflation, which contributed to a stronger euro and the 10-year German yield increased by more than 10 basis points," she said.

Fransson also thinks that financial markets overreacted on Draghi's message but given the overall picture in the U.S. and the euro zone, she expects the dollar to continue weakening against the euro.

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