Euro drops after hitting a three-year high on ECB talk

January 17, 2018 - The euro fell nearly half a percent on Wednesday after rocketing to a fresh three-year high above $1.23 as some investors ramped up bullish bets about the currency, though concerns voiced by policymakers this week damped broader optimism.

Reflecting the apparent disquiet among some ECB policymakers about the euro’s vigour, a remark by European Central Bank policymaker Ewald Nowotny that the euro’s recent strength against the U.S. dollar is “not helpful” encouraged a bout of profit-taking before a policy meeting next week.

“The euro’s strength will cause some concerns to the ECB and it will definitely complicate their policymaking thinking, and some investors are taking profits after the recent rally,” said Adam Cole, chief FX strategist at RBC Capital Markets in London.

Overall dollar weakness and growing optimism about the outlook of the European economy in 2018 has lent fresh legs to the euro’s rally after it gained more than 10 percent last year.

But the speed of the rise in the opening days of 2018 - up more than three percent in the last two weeks - has invited comment from ECB officials this week, highlighting some growing concerns, according to analysts.

In an interview to an Italian daily la Repubblica, Vitor Constancio, the vice president of the European Central Bank, said he did not rule out that monetary policy would still continue to be “very accommodating for a long time”

On Tuesday, Jens Weidmann, Germany’s representative on the ECB’s policymaking body said it would be “appropriate” for the European Central Bank to stop its bond purchases, due to run at least until September.

“The ECB is playing the good cop and the bad cop in terms of their comments over the euro but there is no doubt the currency’s rally has sowed the seeds of uncertainty in the minds of ECB policymakers,” said Viraj Patel, an FX strategist at ING in London.

A Reuters source-based story on Tuesday reported that the ECB is unlikely to ditch a pledge to keep buying bonds at next week’s meeting.

The single currency rose to a session high of $1.2323 against the dollar in Asian trading before falling 0.44 percent to stand at $1.2210.

For euro bulls, these are key levels for a couple of reasons. Unlike in summer 2017, when positioning was not as stretched and valuations were still reasonably attractive, current levels are not as supportive for the single currency.

Latest positioning data showed that net long euro positions are at a record high while both ECB and IMF valuation metrics show the euro is only about 6-7 percent currently, compared to more than 12 percent before the French elections last year.

Morgan Stanley strategists said in a daily note that as long as inflation expectations are met and growth remains strong, the euro’s strength will be tolerated by the ECB.

Source: Reuters