Why the Euro is Weak and What the Outlook Holds

Euro exchange rates are falling on the assumption that the ECB will soon cut interest rates. How far will the decline extend?

The euro remains the currency to watch in global FX after the shared currency fell to fresh 6 month lows against the U.S. dollar.

"After a one-day pause, investors returned to selling the pair in anticipation of easing from the ECB.  No major U.S. or Eurozone economic reports were released today so the decline cannot be attributed to data or ECB speak," says Kathy Lien, Director at BK Asset Management.

An article published by Reuters suggests ECB decision-makers are uniting behind an interest rate cut in December.

If the reports are true we would suggest the declines in the shared currency could run further as the threat of lower interest rates at the ECB are the single most negative factor for the currency at the moment.

Stoking the fire is ECB governing council member Erkki Liikanen who warned of downside risks on the Eurozone’s inflation and growth prospects. He added that the governing council is willing and able to act by using all the instruments available within its mandate.

Falling interest rates in the Eurozone contrast with the prospect of higher interest rates in the United States and United Kingdom.

This divergence will continue to drive the euro lower against both the British pound and US dollar for the foreseeable future it is argued.  

The pound to euro exchange rate has edged higher and is above 1.40 and starting to stabilise around these levesl. We have argued here that the GBP to EUR conversion needs to stay above this important support zone for the uptrend to remain valid.

The euro to dollar conversion is meanwhile around its recent inter-month lows and could well be on track to test 1.04 by the time 2015 is out.

The next level of support for this pair is 1.0670/1.0700.

Looking ahead we have this interesting observation from Jyske Bank's Leander Dreyer:

"Equity markets are beginning to trade with bearish tones, and we know that the correlation between EURUSD and the equity market is very high. If DAX continues to slide, we will see a higher EURUSD rate in the near future. However, for the longer term the divergence between Europe and the US will still send EURUSD lower."

What did the ECB say?

According to a Reuters report, consensus is forming at the European Central Bank to take the interest rate it charges banks to park money deeper into negative territory in December, four governing council members said.

Some argue that a deposit rate cut should even be larger than the 0.1 percent reduction currently expected in financial markets, the policymakers said in what could well be a big negative for the value of the euro.

"Markets were spooked by a Reuters article as it stated that some ECB members support an aggressive deposit rate cut and other far-reaching easing measures. 2-yr interest rate differentials between the dollar and the euro widened again .The report pushed EUR/USD back lower in the 1.07 big figure," says Piet Lammens at KBC Markets.

What is interesting is the observation that Germany's Bundesbank, who once upon a time agressively opposed quantitative easing, has been quiet on the matter since the last ECB meeting.

One policymaker told Reuters that Germany's silence was due in part to its recognition that its own growth momentum and export markets were slowing.

"As you know we don’t target the exchange rate and the Germans will never admit that a cheaper exchange rate would suit them, but that’s why they are silent," the policymaker told the news agency.