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Can the slumping Euro find support as it nears US dollar parity?

12:33, 8 March 2022

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Currency notes of EUR100 and USD100 stashed together
Dutch bank ING says the downside risks for the EUR/USD pair remain sizeable – Photo: Shutterstock

With the unabating pressure on the euro (EUR), the currency is now at the cusp of parity with US dollar (USD), something that has not happened in nearly two decades.

On Tuesday (March 8), the EUR/USD slumped to 1.08, the lowest level since May 2020. Despite shedding 5.2% of its value since the beginning of February, the pressure on the euro is far from over as the war in Ukraine increases economic risks for the eurozone. However, the euro may soon find support before reaching parity with the US dollar.

According to Dutch bank ING, the downside risks for the EUR/USD pair remain sizeable but they will not hit parity.

Support at 2020 lows

“With Russia currently threatening to cut the gas supply to Europe through Nord Stream 1, upside risks to gas prices remain very significant, and so does the downside risk for EUR,” ING said in a note.

The bank expects the euro to slide to the lows of 2020, around 1.06, but expects it to find support there.

Analysts at Skandinaviska Enskilda Banken (SEB) Research are also seeing signs of support coming for the EUR.

EUR positioning increasing

“Bullish EUR positioning among leveraged funds and speculators continues to increase even as the EUR weakens versus the USD. Leveraged funds now have the most bullish EUR positioning since August 2021,” SEB Research said in a note.

At the same time, leveraged funds and speculators are also bringing down their US dollar position. According to SEB Research, leveraged funds and speculators have downscaled USD holdings for four consecutive weeks now.

Similarly, Philip Wee, senior FX strategist at Singapore-based DBS Bank also sees support for the EUR coming in soon. According to Wee, the 14-day relative strength index, which shows whether a currency is oversold or overbought, is below 30 for the EUR, indicating that the currency is oversold.

Eyes on the ECB

“Our Mean Trend Value model sees scope for the EUR to consolidate between 1.0830 and 1.1000,” Wee said.

On a policy to level, the European Central Bank will have to watch out for inflation at its next meeting later this week to keep the euro stable.

“ECB officials will also be laser focussed on the commodity price shock too, and if anything the commodity price shock is likely to be even more inflationary for the eurozone – the eurozone is more dependant on commodity imports from the conflict zone and eurozone energy prices have surged more than US energy prices,” said Richard Franulovich, head of FX strategy at Westpac, in a note.

The ECB's governing council holds its next policy meeting on Wednesday. Last month, the ECB took a hawkish turn following many months declaring that inflation pressures were mainly due to “transitory factors”. While inflation is likely to remain a concern for many months to come, the ECB is expected scale back the hawkishness seen at February's meeting.

Inflationary risks abound

Indeed, experts at Pantheon Macroeconomics said the ECB has its task cut out because of the mounting risks of inflation as well as economic growth from the ongoing war in Ukraine.

“The main challenge for the central bank is that core inflation is headed for +3%, adding to the pressure to withdraw pandemic stimulus, end QE, and ultimately, start raising interest rates.

“From the point of view of an inflation-targeting policymaker, a further increase in energy inflation simply piles on the pressure to adjust policy to close to the increasingly yawning gap between inflation, which will soon hit 6%, and stimulus dialled to the max. At this point, however, the ECB also has to consider that higher inflation today could be disinflationary tomorrow, mainly via the real-income crushing effect of higher energy inflation,” the firm said in a note.

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