Dembik: QE is coming and the euro will slide
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EURUSD is trading at historic lows – the lowest in almost a decade – after breaking the psychological level of 1.20. This may be only the starting point of a deeper and more prolonged depreciation of the euro towards 1.15.
The two key elements behind the drop are the resurgence of the sovereign debt crisis and expectations that the European Central Bank will launch a policy easing program to avoid Japanese-style deflation in the euro area.
Once again, the ECB will have no choice other than to take the lead in order to reassure investors. This means implementing a sovereign bonds purchasing programme despite German reluctance. It may not be the best option to strengthen growth and reinforce inflation but it is the only option left.
The ECB may launch this programme as soon as January 22. Over the past few weeks, pressure has increased on the central bank after the publication of data confirming the increasing risk of deflation in the Eurozone.
For the first time since 2009, year-on-year inflation turned negative, as measured by the December Eurozone CPI estimate, with much of the pressure coming from the 30% plunge in the oil price since Opec’s last meeting in November.
Quantitative easing appears inevitable and the most pressing questions now are the size of the programme and which assets will be purchased. Will Greek and Cypriot bonds be part of it? How long will the operation last? There are plenty of unsolved issues!
Nowadays, monetary policy is like playing with fire. We don’t know all the long-term outcomes of the accommodative measures yet. However, it is certain that the measures being undertaken will not make Eurozone economic structures more efficient or provide any durable solution to the problems of fiscal deficits and public debt.
The picture is not entirely gloomy. Many European countries may benefit from the euro's decrease in value because it improves price competitiveness. But this won’t be enough. The Eurozone cannot win the global race to the bottom in currencies. It is a never-ending battle.
To overcome the crisis, the euro area should tackle key pending issues regarding product competitiveness, wealth transfers from rich countries to the periphery and closer fiscal union.
It will very soon become apparent that expectations about the macroeconomic impact of QE are far too optimistic and that monetary policy is not able to replace government action. Poor economic performance and the risk of exit from monetary union may cause investors to lose confidence in the euro.
Being short EURUSD has been a profitable and very popular trade. More downside movement is probably coming over the next months as it will be obvious that the euro area is not able to get back on the right track.
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