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Foreign Exchange

Super Mario set to drag down the euro?

Short-term moves in EURUSD are likely to depend on the progress of political wrangling over the future of the single currency, but the longer-term outlook is more clouded, given the apparent turnaround in attitude at the European Central Bank.

 

The move higher in EURUSD in recent days has mainly been driven by short covering, with dealers reporting little interest to put on fresh long positions. This seems to make sense given the event risk over the next week. Short-term price movements are likely to be driven by headlines from Berlin and Paris, while there is also the small matter of the crucial ECB meeting.

No deal on eurozone debt leaves EURUSD vulnerable to downside, and it has plenty of room to fall.

On a year-to-date basis, EURUSD is up 1% – albeit 9% below May’s high of $1.4940. Still, the average level of EURUSD since its inception is $1.20, well below current levels.

Should the environment deteriorate rapidly, Camilla Sutton, FX strategist at Scotiabank, says a test of the 2010 low of $1.1877 is a possibility.

“Without a credible plan in place and with uncertainty, low growth and a dovish central bank, the euro is unlikely to maintain its recent upward momentum,” she says.

However, a credible deal on eurozone debt may well force more short covering, especially if it is seen as alleviating the pressure on the region’s banking system.

After all, banks’ positioning data still show that investors are short even after the shake-out of the last few days.

The upside potential for EURUSD thereafter is much more difficult to justify.

One of the factors that has been supporting the euro during the past few sessions has been the feeling that new ECB president Mario Draghi will be more accommodating than his predecessor Jean-Claude Trichet and back efforts to promote growth by expanding peripheral debt purchases and cutting rates.

Indeed, Draghi warned this week about eurozone growth and said the ECB’s mandate was to maintain price stability “in both directions”.

In other words, the ECB is now concerned with growth and deflation, a potentially seismic shift from the hawkish regime of Trichet, who saw inflation at every turn.

For the future of the eurozone, this bodes well and could be instrumental in ensuring that the single currency survives the crisis.

However, the value of the euro is a different story, leaving it with a central bank that is looking to weaken its currency to promote growth and save the EMU project.

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