The ECB is expected to take a pause in its interest-rate-cutting campaign next week, but that’s not likely to bring a reprieve to the EURO, which remains trapped in a vicious cycle of rising government borrowing costs and weak economic data.
The first week of 2011 hasn’t been an encouraging one for Europe’s common currency. After a brief bout of optimism fueled by improved manufacturing data at the beginning of the week, it eventually succumbed to broad pessimism about the debt crisis that’s stalking the 17-nation currency area. By Friday, the EURO had sunk to a 15-month low below $1.27 and its lowest in more than a decade against the yen below Y98.
Efforts by the ECB to quell turbulent markets have had limited import. The central bank continues emergency buying of Italian and Spanish debt, yet Italy’s long-term borrowing costs remain unbowed from their 7% yields, a threshold that economists view as unsustainable.
Italy’s struggles set the stage for the ECB’s policy meeting on Thursday, its first of the year. Most market watchers expect the central bank to keep euro-zone lending costs at 1% after two consecutive 25-basis-point cuts.
Still, analysts are seeking clues that the ECB may undertake more aggressive bond-buying, such as the quantitative-easing championed by the Federal Reserve that led to a sharp depreciation of the dollar. At least for now, ECB President Mario Draghi resists the idea because it isn’t seen as part of the central bank’s mandate.
Italian Industry Minister Corrado Passera, one of Italy’s most powerful policy makers, appeared to urge as much Friday, when he called for Europe to have a “real central bank” that embraced more monetary policy activism.
The EURO is also saddled by intense speculation that a credit-rating downgrade is coming for Europe’s most indebted economies, a move that could increase borrowing costs across the Continent and strip France or Germany of their pristine triple-A credit ratings.
After a period of calm, analysts say the stresses in European bond markets are hurting the EURO again and leading it into a divergence from other risk-sensitive currencies. Investors now appear to be separating the risks engendered by Europe’s debt crisis from other global growth issues. A strong U.S. employment report Friday bolstered hopes for global growth on Friday, but instead of leading investors to higher-yielding currencies, the data boosted the USD broadly.
Next week, industrial production figures in Germany, France and Italy (the euro area’s three largest economies) will provide new hints as to whether the bloc is entering a recession.
The uncertain outlook means the ECB likely will face increasing calls to take more aggressive measures to boost the economy and prevent surging bond yields from destabilizing global markets. All available policy options point to a weaker EURO.
EasyForexNews Research Team