Why is the Euro falling?

The single currency teeters following a QE policy tease from Draghi and noises from Germany that a Grexit would be 'manageable'. But are they the real causes?

by Adam Gale
Last Updated: 05 Mar 2015

Currency traders the world over are shedding Euros like post-Christmas pounds (or kilos, if you’re metrically minded). Last night, the single currency lost 0.6% of its value against the dollar in half an hour, dropping to $1.193. It’s currently trading slightly lower at $1.189. This means that it’s fallen 5.3% since mid December and 16.8% since May.

Like a herd of cows sitting before an impending storm, currency traders seem to have a knack for sensing when something bad’s about to happen. So what’s got them spooked this time?

Grexit

Greece, the cradle of democracy and crib of Europe’s last economic crisis, might leave the Euro. In December, Prime Minister Antonis Samaras brought a parliamentary election forward to January 25th after failing to get his candidate for president approved by the legislature.

Since then, the anti-austerity Syriza party has narrowly led in the polls. Syriza leader Alexis Tsipras has campaigned on promises to end austerity and write off huge swathes of the country’s rather vast debt. Should Tsipras follow up on these promises, Greece could face bankruptcy, and it’s hard to see how it would be permitted to remain in the Euro under those circumstances.

Matters were made worse by a report in Der Spiegel this weekend, in which unnamed German government sources said a Grexit would be ‘manageable’, as ‘the danger of contagion is limited because Portugal and Ireland are considered rehabilitated’.

The German government said it expects whoever leads Greece in February to honour its commitments, but the report has been widely seen as a sobering indication that Greece really could leave.

Quantitative easing teasing

Der Spiegel wasn’t the only German paper to come out with a currency-rocking story over the weekend. Handelsblatt published an interview on Friday, in which Mario Draghi hinted that the European Central Bank (ECB) might finally begin full-scale quantitative easing (QE).  ‘We are making technical preparations to alter the size, pace and composition of our measures in early 2015’, Draghi said.

There’s nothing like a good policy tease to get the markets moving. The ECB has thus far flirted with QE, which involves central banks buying bonds to flood the market with liquidity, but has fallen short of actually committing.

If Europe does go this way – and it could happen as soon as the next ECB meeting on January 22nd – the effective increase in the supply of Euros should cause its value to drop. The recent fall in the Euro, then, could simply be the markets adapting to stronger QE expectations.

It’s the dollar, stupid

Impending events in Europe may have caused the single currency to slide this weekend, but Europe doesn’t exist in a vacuum. The Euro’s recent retreat could be seen as just the latest stage of the dollar’s long advance.

The greenback is riding high against all the major currencies. Persistent worries about the weakening global recovery are causing traders, and indeed central banks, to give up riskier investments for the safety of dollar-denominated assets. Stronger economic performance in the US than Europe and growing speculation that the US Federal Reserve will increase interest rates this year are only making the dollar more attractive.

Grexit fears and QE hopes may well end up as drops in the Atlantic given this greater and ongoing trend. Still, it’s not all bad, eh. A weaker currency should help Eurozone growth by boosting exports, while tackling deflation with more expensive imports. Anyone would think that’s exactly what Draghi wanted when he spoke to the press...

Besides, if you have been hoarding Euros under your bed, you can still get a very decent exchange rate against the rouble.

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