Traders brace themselves for declines as euro trades near 17-month high against US dollar

LONDON – By some measures, the euro is at its most expensive level on record, potentially setting itself up for a fall if it starts to undermine the euro area economy and forces the European Central Bank (ECB) to turn dovish.

The common currency’s so-called nominal effective exchange rate, which compares it with the currencies of the euro area’s trade partners, has never been stronger. It is also near its highest level against the renminbi in three years, potentially dimming the appeal of the region’s exports at a time when a slew of data shows that both the European and Chinese economies are foundering. 

The euro’s strength is “absolutely” a concern for the ECB, said Mr Mark Dragten, head of discretionary foreign exchange at Insight Investment. 

“Europe sells a good deal of products to China,” he said. “You have to wonder about demand when the Chinese economy is slowing.”

Although the ECB looks at a range of currency measures besides the nominal effective exchange rate, the currency’s gains are starting to look precarious. 

The euro trades near a 17-month high versus the US dollar, up more than 18 per cent since falling below parity with the greenback in September, as the ECB delivered the most aggressive monetary-tightening cycle in its history. It has also shot up against the yen and recently jumped versus the pound.

Technical signals suggest that the currency is overbought. There has been a bearish reversal of the euro’s nine-week relative strength index, while the Commodity Channel Index – which measures current prices relative to historical levels – has started to fall, pointing to losses ahead.

The euro-dollar “has no business up here” and the ECB knows it, said Jefferies strategist Brad Bechtel.

Should ECB president Christine Lagarde ease off on her aggressive inflation-fighting rhetoric when officials meet on Thursday, the euro could go the way of the British pound. Sterling’s winning run hit a wall when British price-growth data came in surprisingly slow last week.

“The euro and the pound are a bit ‘over their skis’ relative to reality,” Mr Bechtel said, predicting that the euro will fall back to around US$1.1080 from about US$1.1114 on Friday.

Analysts surveyed by Bloomberg forecast that the euro will drop to US$1.10 by September before ticking higher to US$1.12 by the end of 2023.

Currency strength may feature in the ECB’s messaging this week, according to Mr John Hardy, head of foreign exchange strategy at Saxo Bank. The central bank “is likely worried on the currency front and recognises it as a risk on the growth side of the economy”, he said. 

The ECB is widely expected to lift rates by a quarter point to 3.75 per cent on Thursday and investors will scrutinise Ms Lagarde’s remarks for clues on whether another hike in September is likely. 

Recent economic data out of the euro area has missed forecasts, driving down Citi’s Economic Surprise Index, which measures data surprises relative to market expectations. The gauge has been diverging from its United States equivalent over the past two months.

A string of economic data due this week will help policymakers shape their next steps, including purchasing managers’ index figures for France, Germany and the rest of the euro area on Monday that are mostly forecast to slow.

On Tuesday, the widely followed German IFO expectations indexes will come out, and on Friday, France will release its second-quarter gross domestic product report, with growth predicted to decelerate on a yearly basis.

“The big test is going to be growth,” said Mr Kit Juckes, chief currency strategist at Societe Generale. “The European economy needs to show a bit more resilience.” BLOOMBERG