The Euro-Dollar Rate was Sold by Central Banks in First-quarter says MUFG

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- EUR sold by central banks in Q1 despite bargain prices says MUFG

- EUR now undermined by prospect of more ECB rate cuts and QE.

- EUR range-bound next week but could find support later in 2019.

- As deteriorating Fed outlook provides an offset to ECB actions.

The Euro was sold by central bankers in the first-quarter despite it declining to bargain levels according to analysts at global banking giant MUFG, who say the single currency is likely to remain in a narrow range this week but that it may recover some lost ground by year-end. 

Europe's unified unit entered 2019 trading at above the 1.1450 level but by the end of the first-quarter in the dying days of March it had fallen to an 18-month low beneath the 1.12 handle, which left even more undervalued than it had been at any point in the punishing year that was 2018.

But these falls to new lows were not enough to draw central bankers off the sidelines, which is notable according to MUFG, the world's fifth largest lender and a significant foreign exchange dealer. 

The world's central banks, the masters and commanders of the global monetary system, tend to buy other currencies during or after declines in prices according to MUFG. Central banks actually need to own foreign currencies to reliably safeguard their own while price falls make foreign units cheaper to buy.

Above: Euro's share of global central bank reserves. Source: MUFG.

"We have highlighted the fact that central banks have been strong buyers of EUR and this tends to reflect the falling value of EUR and this demand recedes when EUR rebounds. However, this pattern was not evident in Q1 with EUR/USD drifting lower but demand from central banks declining. In constant FX terms, we estimate central banks were net sellers of EUR," says Lee Hardman, a currency analyst at MUFG. 

MUFG has calculated, using Composition of Foreign Exchange Reserve (COFER) data from the International Monetary Fund, that the world's central banks may have sold as much as $12.8 bn worth of Euros during the first-quarter of 2019. That's an insignificant amount when compared with the $608 bn of Euros that central banks bought in the previous two years, although the fact they were sellers at all is notable. 

The absence of central bank buyers of the Euro from the currency market in the New Year is made all the more significant by the fact that, for the first time, the IMF's COFER data contained a full breakdown of China's foreign currency reserves which was kept confidential until very recently. That means the first-quarter data is more accurate than it's ever been before. The data now accurately reflects the split between 94% of all known reserves held by the world's central banks.

"The EUR sales resulted in the EUR composition in nominal terms falling to 20.2% in Q1, the lowest total since Q4 2017 and some way off the record high of 28% set in Q3 2009 ahead of the euro-zone crisis that has clearly impaired appetite for EUR," Hardman writes, in a note to MUFG clients. 

Above: Euro-to-Dollar rate during the first-quarter of 2019.

Central bank sales of the Euro began after a torrid six-month period for the Eurozone economy and amid negotiations that were, at the time, expected to end the trade war between the U.S. and China that has wrought so much damage on the global growth outlook and helped hobble the European expansion last year. 

Sales also preceded official data that showed the Eurozone economy growing by 0.4% in the first-quarter, up from 0.2% at the end of 2019, which left the continent appearing as if it had drawn a line under two consecutive quarters of anaemic growth.

That would appear to have been bad timing if not for the fact that Eurozone growth indicators have since turned downward, inflation has fallen and the European Central Bank (ECB) is now believed to be gearing up to clobber the Euro with more interest rate cuts and another round of quantitative easing in order to resuscitate the economy. 

"The euro’s attempt to break higher against the US dollar in recent weeks has been rejected after it failed to sustain levels above the 200-day moving average at around 1.1330. The euro has been undermined over the past week by building expectations for looser ECB policy," Hardman says.

Above: Euro-to-Dollar rate shown at daily intervals.

Hardman and the MUFG team say a combination of market expectations for interest rate cuts in both Europe as well as the U.S. should be enough to keep the Euro-to-Dollar rate within a narrow 1.1150-to-1.1400 range over the next week or so. 

However, the bank forecasts the single currency will finish 2019 up at 1.16 against the Dollar because it also projects the Federal Reserve will cut U.S. interest rates to a larger extent than its Eurozone counterpart.

But for now, concerns about the policy outlook may have kept the central bankers at bay earlier this year, have certainly kept the market at bay in recent weeks and may continue to do so for a while yet. 

"The nomination of IMF Chair Christine Lagarde to be the next ECB President after Mario Draghi’s term ends in October has reinforced expectations for looser ECB policy. Market participants see her as more of a status quo candidate who is likely to support cutting rates and restarting QE. It has resulted in fresh record lows for euro-zone yields which further undermines support for the euro," Hardman writes. 

Changes in interest rates are normally only made in response to movements in inflation but impact currencies because of the push and pull influence they have over capital flows, and their allure for short-term speculators.

Capital flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency. Rising rates have the opposite effect.

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