Traders have increased bets that the euro could fall to parity with the greenback as stubbornly high inflation and steady U.S. growth raise the likelihood that the Federal Reserve will begin cutting interest rates months after the European Central Bank. Those forecasts received a fresh boost from comments by Banque de France President and ECB Governing Council member Francois Villeroy de Gallo that uncertainty in oil markets should not deter the institution from its first interest rate cut in June.
In an interview with “Eko” published on April 21, De Gallo points out that even if the conflict in the Middle East increases the costs of black gold, monetary strategists should not react mechanically, but after a thorough analysis of expectations whether such a shock will raise prices.
What the ECB’s decision will be will become clear at the official meeting of the bank’s governing board on June 6. But even if European central bankers do cut eurozone interest rates, their future actions are less clear because they are divided on how much rate cuts they should make. De Gallo himself, who is a passionate supporter of the loosening of monetary discipline, emphasizes that the subsequent reductions in interest rates must happen “with a pragmatic speed”.
Meanwhile, investors are buying options that will be profitable if the single European currency falls to $1. dollar or less. Based on the pricing of these options, Bank of America strategists say markets are now pricing in more than a 10% chance of that scenario playing out over the next six months, down from nearly 0% in early January.
The euro has already depreciated by 3.5% against the greenback since the beginning of January. Parity between the two currencies would require a further decline of almost 6.5 percent. According to currency analysts, markets seem to have given up on forecasts of interest rate cuts across the Atlantic, but are absolutely certain that the ECB will start lowering rates in June.
Signs of stubborn inflation and sustained growth in the United States have traders hedging bets on the speed at which credit costs will fall in the world’s largest economy. They are already pricing in a maximum of two interest rate cuts of 25 basis points each by the Federal Reserve by the end of the year. Unlike the US, annual inflation in the eurozone fell to 2.4% in March – close to the ECB’s 2% target, and growth remains symbolic.
The IMF indicates in its new economic outlook published on April 16 that the US GDP has the potential to increase by 2.7% in 2024 – more than three times that of the euro bloc. Fears of a widening conflict in the Middle East and the potential inflationary impact of higher oil prices also fueled warnings of a blow to the single European currency due to Europe’s dependence on energy imports.
The euro is priced at parity with the US dollar in 2022 for the first time in two decades, following the shock of a spike in energy prices following Russia’s invasion of Ukraine and a mass flight to the greenback. At the moment, the American economy is not weakening, and the danger of an increase in crude oil prices is increasing, which dramatically increases the risk of further depreciation of the euro and even parity with the dollar, according to the currency experts of Bank of America. ECB President Christine Lagarde has indicated that she and her colleagues will monitor “very closely” the prices of the black gold, but notes that Israel’s market response to the Iranian strikes has so far been “relatively moderate.”
Signs of an escalation in the Middle East could also push the greenback higher because investors typically gravitate toward safer assets, such as the US dollar, in times of crisis. Deutsche Bank and JPMorgan Chase have warned that the ECB may need to keep a closer eye on borrowing costs after the first cut because interest rate differentials could lead to excessive weakness in the single European currency and risk a fresh inflation spike from higher prices of imported goods.
However, some currency strategists believe that European central bankers may not be opposed to a gradual weakening of the euro after they have begun to pay more attention to threats to growth than to inflation. A cheaper euro will help exporters and the boost to growth will be welcome for a number of countries in the region, such as France and Italy, which are grappling with swelling deficits.
