Here’s how the ECB could deliver a euro shock
The battered euro has fallen fast and furiously in recent months—and may have to brace for another drubbing if the European Central Bank (ECB) delivers "shock and awe" monetary stimulus this week.
Analysts expect the ECB to unveil a sovereign bond-buying program worth in the region of 500-600 billion euros ($579-695 billion) to fight deflation and lackluster growth in the euro area. Such a number is already priced into markets and is expected to give the single currency some relief.
However, that's not the only possibility, and as the Swiss National Bank demonstrated last week, central banks are not afraid to deliver the unexpected.
"If we see a real policy of shock and awe being conducted from the ECB, then easily we could find ourselves sub-$1.10 (for the euro), looking at $1.08 relatively quickly," said Jeremy Stretch, a markets strategist with the Canadian stock broking firm CIBC.
"And if that happens, clearly the parity threshold would be discussed widely."
The euro traded at around $1.1579 on Tuesday, not far from an 11-year low hit last week of $1.14595. The currency has fallen roughly 14 percent in the last six months, fueling speculation that a move towards parity against the dollar, something that has not happened since 2002, could be on the cards.
"There are financial institutions out there that do take that view and have built in a forecast for parity," said Neil Mellor, a currency strategist based in London at Bank of New York Mellon.
"If the ECB does deliver a bigger figure in terms of quantitative easing, that would be quite something indeed," he added.
Mellor said that the Bank of New York Mellon was looking for the euro to weaken to around $1.07 on a six-month basis, reaching the one-to-one level against the greenback over a 12-month period.
However, strategists stressed that given the heavy short positioning on the euro – suggesting a view by currency speculators that the single currency will weaken –there was scope for a short-term bounce.
"If they (ECB policymakers) imply a very large figure in the region of one trillion (euros) and the credit risk was neutralized, then I would argue that the profile for the downward path for euro/dollar would be somewhat steeper," said Derek Halpenny, a currency strategist at Bank of Tokyo-Mitsubishi. "But I am certain of view we get some respite and some reversal of euro shorts."
And if the ECB delivered a different surprise, one where it chooses to take no action, then any bounce in the euro could be steep, Mellor said.
"If the ECB does nothing, the euro will go higher; there will be no surprise in that – especially because the market is very short," he said. "That would be an unexpected outcome, for obvious reasons."
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