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What Next for EURO ?

January 23, 2015

 In my previous note “Why SNB Opted for Unconventional Monetary Policy” I made a closing remark about ECB quantitative easing plan and said that if the QE amount ranges around Euro ½ to ¾ Trillion, it may not be very effective, as European economy is required to bet on larger size.

The current size of ECB bond buying that will begin in March is surely more than expectation. ECB announced that it will make a monthly purchase of up to maximum of 30 pct of Investment grade bond (Central Bank) of Euro 60 billion until September 2016, which is Euro1.140 Trillion that should not include Greek Bonds, as it does not meet the qualification standard.

To make its loose monetary policy effective, European Central Bank has already hinted that more could come if necessary, which also means that the stance is aggressive, as they are flexible to adjust the size of asset purchase accordingly.

It will increase the size of ECB Balance Sheet to nearly USD 3.84 Trillion, but would still not surpass FED balance sheet, which is expected to see a modest drop of around USD 149 billion in 2015 from its current size of USD 4.2 Trillion.

ECB seriously wants to get rid of deflation, as growth and employment is the top priority. But by putting condition of purchasing investment grade bonds, it is estimated that 80 pct of the risk will be taken on Central Banks and reaming amount will be distributed in European system in a span of 19-months. This may not be sufficient to give kick start to the ailing European economy.

The fruits of weaker Euro will have lag effect and may take some time to reflect, but future growth prospects now looks brighter than recent past.

Due to the size of ECB asset purchase announcement, pressure will mount of the European currency that will remain soft for months, as ECB opted to keep pace with Bank of Japan.

Furthermore, the world is already witnessing improving job condition and economic growth in USA and UK economy, despite some recent weaknesses is better placed due to its past aggressive bond buying policy and easy monetary stance.

Similarly, ECB has taken a leaf from the same page to do some constructive work, as Central Bank of Canada, Denmark, RBI and SNB are also in easing mode.

Next week, market will have more clarity after Greek election, which could spark volatility and could see some choppy moves before sentiment is shifted towards developments in USA.

Market players will once again start looking for direction after the release of FOMC statement due next week, which could have a Dovish posture. Otherwise, if the FED language remains pro-growth, good number of investors/traders would still believe earlier US rate hike, which I do not see happening before the last quarter.

However, with global easing mood to mend their respective economies and strong US economic growth tone, I would like to make downward revision of Euro from my yearly target of 1.1250, which is already met to 1.0950. Further, base line support is around 1.08 levels, which should hold or else breach could witness test of 1.05 levels. On the up, Euro is required to penetrate beyond 1.1780-00 levels for 1.2050.

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