The Euro hits Mult-Month Best against Pound, Dollar but Risk of Overshoot Grows
- Euro to Pound Sterling exchange rate: 0.8860
- Euro to Dollar exchange rate: 1.1358
The liquidity of global foreign exchange markets is falling as is often the case in the Northern Hemisphere’s summer.
This can spell for greater volatility in foreign exchange markets as moves are exacerbated by a fall in the number of buyers and sellers in the market.
We saw a classic example of that in Tuesday June 27’s movements with the Euro enjoying its strongest day in more than a year in response to European Central Bank President Mario Draghi’s suggestion that Eurozone’s improving economy no longer needed the central bank’s “very substantial” support.
This support, in the form of record-low interest rates and quantitative easing, has long kept the Euro well below fair-value.
Above: Watch ECB President Mario Draghi talk up the Eurozone economy and the Euro at the ECB Forum on Central Banking in Sintra, Portugal.
Analysts at UBS say some of their studies suggest EUR/USD fair-value could be as high as 1.25.
“President Draghi's more hawkish inclinations have set tongues wagging, with markets now seeing the end of the ECB's QE policy as a matter of when, not if,” says Viraj Patel, an analyst with ING Bank N.V.
The Euro raced higher against all its competitors. The EUR/GBP exchange rate is seen extending gains to reach a seven-month best at £0.8874 at the time of writing, having started the week at £0.8799. This equates to a seven-month low in the Pound to Euro rate at 1.1269.
The EUR/USD exchange rate is at nine-month best at 1.1358 having started the week at 1.1119.
Draghi added that while current policy is correct, "reflationary forces" suggest potential room to pare stimulus, very gradually.
"The market has interpreted this as tapering the QE programme next year, driving German yields higher and EURUSD up through recent 1.1300 highs," says Robin Wilkin, an analyst with Lloyds Bank.
Can the Rally Continue?
The gains in the Euro are yesterday's news. What does the future hold?
Looking at the charts momentum on the main Euro-based pairs is in positive territory and those that follow trends will tell you that it would be futile to stand in the way of the Euro in current conditions.
“In light of positive Eurozone data, few can question Draghi's optimism and for this reason, the move in EUR/USD could extend as high as 1.15,” says Kathy Lien, Director at BK Asset Management in New York.
But Lien cautions that it is also important to realise that a large part of the rally can be attributed to ‘short-covering’ and that "flow will start to ease as sellers turn into buyers".
Short-covering is the process whereby those who were originally betting against the Euro liquidate those trades; so it is a technical phenomenon.
“Investors should not get carried away,” warns ING’s Patel. “The implicit reference to removing accommodation in line with changes in the neutral rate suggests a very slow normalisation process.”
Patel says EUR/USD beyond 1.14-1.15 “could be seen as an overshoot”.
