Euro Forecast - Looming ECB Response to Greece Offers Downside

The European Central Bank will push the euro lower further if it takes further action to keep peripheral Eurozone countries safe from the spread of Greek-inspired financial risk says a new exchange rate forecast.

Greece can stay in the euro or leave - neither is a critical to the outlook for the euro exchange rate longer-term simply owing to the small size of the Greek economy.

Indeed, during the depths of the ongoing Greek saga the euro to dollar conversion rate failed to break below 1.10.

The upper limit of 1.14 remains relevant as a barrier beyond which buying interest in the shared currency tends to fade ensuring those with currency payment needs can make relatively well informed guesses as to where markets are headed.

The pound to euro exchange rate remains stuck below 1.42 but above 1.40, caught in what seems like an unbreakable bind.

This is because the prime driver of the euro remains the European Central Bank’s policy on interest rates, and importantly, quantitative easing. When we see moves on this front will we likely see meaningful moves in the shared currency.

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Euro Outlook Depends on ECB Reaction

Greece will only have a direct bearing on the exchange rate’s outlook via decisions taken at the European Central Bank on a pan-European level.

“Despite the resilience of the euro during the latest chapter of the Greek saga (which as we mentioned last week is  likely the result of the euro’s status as a funding currency),  the turmoil has only added motivation to the ECB’s balance sheet expansion,” says analyst Royce Mendes at CIBC.

Indeed, ahead of Greece voting 'no' on Sunday ECB board member Benoit Coeure said the central bank stands ready to take additional measures amid the uncertainty:

"In the current circumstances of great uncertainty in Europe and the world, the ECB has been clear that if we need to do more we will do more. We will find the necessary instruments.”

"Our will to act in this matter should not be doubted."

For the euro exchange rate the ECB’s response will be key particularly in its efforts to fight the contagion of negative market sentiment which could spread to other Eurozone economies such as Italy, Spain and Portugal.

“In the near term, the ECB may  need to make targeted purchases of peripheral country  debt to make good on its ‘whatever it takes’ promise,” says Mendes.

While longer-term, the ECB is still quite a distance away from its target balance sheet size of about €3 trillion the ongoing volatility could well make President Draghi consider expanding the program.

“Continued  purchases should drive further weakness in the euro against the greenback and we should see a bottom of around 1.05 in Q3,” says Mendes in a recent euro forecast update.  

More Forecasts for Euro / Dollar Following the No Vote:

The markets opened today with the euro on the decline as far as EUR/USD 1.0970, vs. a closing price on Friday of 1.1114; however, the single currency is already recovering, and has hit a high of 1.1088.

"The response of the exchange rate, therefore, is very similar to last Monday’s, which nonetheless was broader, with a low below EUR/USD 1.0955. Compared to last week, the picture is now more complex, and uncertainty is higher, and will stay so at least for another couple of days. Therefore, a further drop of the euro cannot be ruled out: beyond EUR/USD 1.0955, the following key support is 1.0800. Should the prospect of Grexit become tangible, the exchange rate could drop rapidly as far as its March lows, to between EUR/USD 1.05 and 1.04," says Asmara Jamaleh at Intessa Sanpaolo.

A Euro Positive: The Eurozone Economy is Doing OK

A forecast for euro / dollar bottoming around 1.05 is well clear of the 1:1 exchange rate many have forecast.

This is understandable as while there is scope for a stronger dollar to exert downward pressure on the rate there remain signs that it is not all bad in Europe, and this could well limit downside potential.

Economic growth in the currency bloc rose to a four-year high in June, according to the Markit Eurozone PMI.

The Composite Output Index hit 54.2 in June, up from 53.6 in May.

The upturn in June also took the average index reading for the second quarter as a whole to a four-year high.

Rates of growth improved in both the manufacturing and service sectors during June.

This tells us that the Greek crisis appears to have so far had little impact on the eurozone economy as a whole.

If the ECB believes this to be the case then it may be less aggressive in targeting that ambition for a balance sheet of 3 trillion EUR.

The second the market gets a sniff of this being the case you can bet your bottom dollar they will push the euro higher.

The timing of this moment of clarity will be the single most important event for the euro complex in coming months we believe.

Take advantage of a weaker euro while you can.