The European Central Bank fears the euro

The financial markets are awaiting the meeting of the European Central Bank (ECB) on Thursday, October 26. During this meeting, the ECB will present a follow-up to the asset purchase program (QE) that expires at the end of December. The ECB continues for fear that the withdrawal could have serious negative consequences for the euro.

The ECB buys nearly €3 billion worth of (government) bonds and other assets every trading day to support the European economy. Although economic growth is clearly picking up in many countries, the bank does not intend to stop this program. In the run-up to the meeting, it was already announced that the purchases would be continued until September or even December next year.

Yet the financial world is holding its breath. There is every indication that the ECB will reduce the size of the support measures. The big question is: by how much. Most economists predict that the current figure of $60 billion per month will be scaled back to $20 to $30 billion.

European economy on its own feet
The eurozone is heading for economic growth of more than 2% this year. That's one better than the 0,1% average. That average is for the years in which there was no purchase program yet. It seems that the European economy will soon be able to stand on its own two feet again. The main reason why the ECB continues to buy is the signal that the stimulus program is coming to an end.

The next step in the normalization of policy is to raise interest rates. Rising interest rates will boost the value of the euro. And the ECB is not waiting for that. A more expensive currency puts a brake on the export sector and that threatens the good economic recovery that is now taking shape.

delay tactics
At the beginning of September, the bank already got a taste of what could happen if the buying program is stopped. At the time, the ECB announced that it would unveil its plans at its next meeting. Immediately after this announcement, the euro rocketed to its highest level against the dollar in more than 2 years.

The ECB's strategy is aimed at convincing the market that a rate hike will not be discussed before 2019. In the United States, the Federal Reserve, meanwhile, is less cautious about raising interest rates. The most likely scenario is that US interest rates will be at 2% by the end of next year. The increasing interest rate differential with the euro makes it more attractive for parties to hold their assets in dollars.

Rapids
Due to the prospect of a European rate hike being delayed, the US currency (after declining 13% in the first 8 months of 2017) has appreciated by 2% since mid-December. That advance could gain momentum when the ECB remains silent on Thursday about adjustments to the size and duration of the purchase program.

On the other hand, any hint of an end to the stimulus, or a larger-than-expected cut in the monthly amount, will cause the euro to reverse its recent decline. If there are no major surprises, the exchange rate will likely float sideways through November 1. Then the Federal Reserve is in charge again.

Lawrence Martins

Laurens Maartens is a currency expert at the Dutch Payment and Exchange Company (NBWM). Maartens analyzes current currency developments and also provides lectures and training in the field of currency management.

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