irmal Bang has come out with quarterly currency outlook. According to the research firm, with the stabilization in peripheral yields coupled with improvement witnessed in euro zone benchmark yield, yield equation is likely to remain supportive for euro.
US Dollar to lose momentum
After a string of policy responses from the Central banks of the developing world, it is turn of Central banks from the developed world to put their foot forward after keeping mum for quite some time. We expect a whole lot of monetary policy responses in the next two months, the father of all could be the announcement of another round of quantitative easing from the US Federal Reserve. The likelihood of this event is likely to put the US dollar on a downward spiral against major currencies like euro, pound and Australian dollar. Among other policy actions, the prominent ones could be a 25 basis point rate cut by European Central Bank and an expansion in quantitative easing by Bank of England (Known as Asset Purchase facility). A section of market also expects the ECB to consider another round of Long Term Refinancing Operation (LTRO) for three years. However, we believe ECB would opt for a rate cut to boost the credit flow from the banking system and support the faltering economy. Going with LTROs will further inflate the loan book of ECB and it may not be willing take any more of these unsecured loans on its book. The politicians at the European Summit has responded well by taking some bold steps, to let their rescue fund inject aid directly into stricken banks from next year and intervene on bond markets to support troubled members like Spain and Italy.
Euro to recover ground
The relatively surprising outcome of the EU Summit is a good step forward and seems to have a stronger effect. Now the ball moves in ECB’s court where Mario Draghi has a chance to contribute to stabilization with the rate cut and perhaps more steps, after he got action from the governments. Since the upside risk in price rise has been ruled out by ECB, it also gives ECB cushion to act on policy rates. In addition to a 25 basis point cut in interest rates, ECB can also go to extent of reducing deposit rates to zero levels which is currently at 0.25 percent. We believe that a 25 basis point rate cut is already discounted in euro and benchmark bond prices which will prevent any significant downside in euro from the current levels. Perhaps, a rate cut will improve the prospect of credit flow to business in euro zone, leading to pick up in economic activity. With the stabilization in peripheral yields coupled with improvement witnessed in euro zone benchmark yield, yield equation is likely to remain supportive for euro.
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