Is the euro on track for parity with the US dollar?

The euro is under pressure as it becomes increasingly likely that the European Central Bank is preparing additional stimulus measures.

The euro extended its losses this week as traders became more convinced that the European Central Bank (ECB) is about to further relax its monetary policy when it meets on Thursday, 3 December.

A soaring US dollar, buoyed by speculation that the Federal Reserve is ready to raise interest rates in December, added to the pressure on the euro. The euro-dollar pair slid a further 1% from 20 November, coming close to the 12-year low it hit seven months ago.

Draghi primes the markets for more QE

The ECB is expected to announce additional easing measures at its policy meeting next week. Currently it operates a deposit rate of -0.2%, meaning banks are charged to park cash at the central bank overnight, and buys €60 billion a month in government bonds.

Options include expanding its quantitative easing (QE) programme to include other asset classes, extending the programme beyond the September 2016 finish date, or pushing already negative interest rates even lower.
Citing ECB sources, Reuters reported this week that the ECB is considering various steps to stimulate inflation, including two-tiered bank charges and broader bond purchases.

Mario Draghi, the president of the ECB, has for several weeks been priming markets for an extension of QE should the conditions warrant. "If we decide that the current trajectory of our policy is not sufficient to achieve our objective, we will do what we must to raise inflation as quickly as possible," he told a conference in Frankfurt last week. (Try not to think of “doing what we must” as an echo of Mr Draghi’s now-legendary remarks back in July 2012, when he pledged that the ECB would do “whatever it takes” to save the euro as Greece’s debt crisis threatened to collapse the Eurozone…)

Bond markets reveal investors anticipate more stimulus, and most likely this would be a further cut to the deposit rate and fresh asset purchases. Bond yields sank this week, with two-year yields in Germany and France plunging to new lows.

A tricky balancing act for the ECB

While the euro has been pushed lower on speculation that the ECB is ready to pull the trigger on additional stimulus, investors are deciding whether the bank can offer any fresh surprises on 3 December – but has euro weakness been fully priced in yet?

Weakening the euro is not one of the ECB’s stated aims, but the currency’s slide is useful for the central bank’s main goal of maintaining inflation at close to 2%. Any spike in the euro caused by the ECB falling short next week could derail attempts to stimulate price growth in the Eurozone. This makes it a tricky balancing act for Mr Draghi and co.

Expectations are running so high that it could be hard for Mr Draghi to announce anything not already anticipated – by definition, that which is expected isn’t a surprise. What’s really quickening pulses is the report from Goldman Sachs that suggests the euro could achieve parity with the US dollar within months.

Whatever the ECB does, its effect on any euro-dollar movements will be overtaken by the actions of the US Federal Reserve when it convenes two weeks after the ECB, on 15 – 16 December.