Euro rally ends as ECB hints at rate cut
The euro’s six-week rally against the pound and US dollar has come to an unceremonious end, as the European Central Bank hints it might cut interest rates below 0.75% in 2013.
Welcome to the Pure FX account of the latest changes in the euro exchange rate, covering the 30th November to 7th December 2012. This is intended as a brief guide to movements in the euro this week, to put you in the best position for when you exchange currencies.
If you plan to transfer money to Spain or Portugal, there may finally be some good news for you from the foreign exchange market this week. This is, the euro’s six-week rally against the pound and US dollar has come to an unceremonious end, as the European Central Bank hints it might cut interest rates below 0.75% in 2013.
This was widely unexpected and caused the euro to lose more than a fortnight’s gains against sterling in just one day, while falling to a week’s low against the greenback. Furthermore, if the central bank goes ahead and carries out its threat next year, we can expect these euro losses to extend.
The ECB’s admittance that it discussed raising interest rates was a shock because, in recent months, the central bank has repeatedly argued that the ‘transmission mechanism’ by which cuts in the interest rate filter through to the Eurozone’s real economy is damaged.
To put it another way, in normal circumstances, ECB rate cuts are beneficial because they lead to commercial banks reducing the amount of interest they charge to loan money. This leads to more people taking out mortgages, and more businesses borrowing to invest, because credit is cheaper. In short, lower interest rates spur economic growth.
Yet, what with the financial crisis, banks have become incredibly cautious about lending, chiefly because they’re afraid to get themselves into the same situation as before the crash, when a large proportion of their loans were untenable. Therefore, though Eurozone banks may ‘pass on’ an ECB rate cut, that doesn’t matter if they’re simple unwilling to lend.
This is what the central bank means by the ‘transmission mechanism’ being damaged. It also makes it surprising that the bank would want to cut interest rates now. After all, it’s not as though high street banks have grown any more relaxed in the last month.
However, it could be that, with the Eurozone in recession, the European Central Bank is eager to use all and any available tools to encourage growth. This is especially the case given that, in this same press conference in which the central bank revealed it had discussed a rate cut, it reduced its growth forecasts for the Eurozone next year.
The Eurozone as a whole is now predicted to shrink –0.3% in 2013, compared to previous forecasts for 0.5% growth. Obviously, this is quite an extreme downgrade, and with political paralysis across the continent still prevailing, the ECB may feel it incumbent upon itself to do what it can.
That then is what caused the euro to fall against the pound and euro this week. Furthermore, we can expect the common currency to fall further, once the ECB actually goes ahead and cuts rates next year, as I mention.
Get in touch: I do hope you’ve enjoyed reading this update. To find how what I’ve talked about here will affect your euro transfers, fill your details into the form below. I’d be delighted to answer any questions you may have.
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Pure FXPeter Lavelle is an economist at foreign exchange broker Pure FX. For a free no-obligation quote regarding changing currencies, get in touch at foreign exchange specialist Pure FX.
Copyright: Peter Lavelle, Pure FX
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