(Bloomberg) – By some metrics, the euro is at its most expensive on record, potentially bracing for a tumble if it begins to undermine the eurozone economy and forces the European Central Bank to turn dovish.
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The so-called nominal effective exchange rate of the common currency, which compares it to the currencies of trading partners in the euro zone, has never been stronger. It is also near its highest level against the yuan in three years, which could reduce the region’s export appeal at a time when a slew of data shows the European and Chinese economies are collapsing.
The strength of the euro is “absolutely” a concern for the ECB, said Mark Dragten, head of discretionary currencies at Insight Investment.
“Europe sells a lot of products to China,” he said. “You have to wonder about demand as China’s economy slows.”
Although the ECB is considering a range of monetary measures in addition to the nominal effective rate, the common currency’s gains are starting to look precarious.
The euro is trading near a 17-month high against the dollar, up more than 18% since falling below parity with the greenback in September, as the ECB launched the most aggressive round of monetary tightening in its history. It also climbed against the yen and recently surged against the pound.
Technical signals suggest the currency is overbought. There was a bearish reversal in the nine-week euro relative strength index, while the Commodity Channel index – which measures current prices against historical levels – began to decline, indicating losses to come.
“The euro-dollar has no place here, and it knows it,” said Brad Bechtel, strategist at Jefferies LLC.
Should ECB President Christine Lagarde relax her aggressive inflation-fighting rhetoric at officials’ meeting on Thursday, the euro could go the way of the pound. The British pound’s winning streak hit a wall when data on UK price growth came surprisingly slowly last week.
“The euro and the pound are a bit ‘over their skis’ compared to reality,” Bechtel said, predicting the euro will fall back to around $1.1080 from around $1.1114 on Friday.
Analysts polled by Bloomberg expect the euro to fall to $1.10 by September before rising to $1.12 by the end of the year.
What Bloomberg strategists say…
“Based on a yield differential, the Euro is expected to trade below $1.10. The advance to 17-month lows was supported by demand for options, but essentially little changed in the macro backdrop. The market’s tendency to overreact to news of the end of the Fed’s tightening cycle was once again evident and new catalyst is needed for the common currency to resume its bullish trend.
— Vassilis Karamanis, FX strategist
The strength of the currency could feature in messages from the ECB this week, according to John Hardy, head of FX strategy at Saxo Bank. The central bank “is probably worried on the currency front and recognizes that as a risk on the growth side of the economy,” he said.
The ECB is expected to hike rates a quarter point to 3.75% on Thursday and investors will be watching Lagarde’s remarks carefully to see if another hike in September is likely.
Recent economic data from the eurozone missed forecasts, dragging down Citi’s Economic Surprise Index, which measures surprise data against market expectations. The gauge has diverged from its US equivalent over the past two months.
A slew of economic data due this week will help policymakers chart their next steps, including PMI numbers for France, Germany and the euro zone on Monday that are mostly expected to ease. On Tuesday, Germany’s widely-watched IFO anticipation indices will be released and on Friday, France will release its second-quarter GDP report, with growth expected to slow on a year-over-year basis.
“The big test is going to be growth,” said Kit Juckes, chief currency strategist at Societe Generale. “The European economy needs to show a little more resilience.”
An eventful and data-packed week is forecast, with the ECB and Federal Reserve both expected to raise interest rates by a quarter point, as investors search for clues on the prospects for further monetary policy tightening. Bank of Japan to also announce policy ECB releases second quarter bank lending survey, while PMI and inflation figures to provide latest update on economic growth and price outlook
Lagarde’s post-meeting press conference is the only scheduled speaking engagement
The UK calendar is set to take a break ahead of the Bank of England’s policy decision next month, with June PMI figures the only economic data of note
Germany, Italy and Belgium are expected to sell about 17 billion euros ($18.9 billion) of bonds next week. Britain’s DMO will sell £3bn of 15-year debt and the BOE will hold a QT sale of medium-maturity notes. Moody’s Investors Service reviews the Netherlands
–With assistance from Alice Gledhill.
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