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The euro was on track for an eighth straight week of losses against the dollar as investors reacted to the widening gap between the faltering euro zone economy and robust U.S. growth.
The currency has fallen more than 5 percent since mid-July, trading at $1.07. In broad signs that the euro zone economy is headed for a downturn, continued weakness in the euro zone reflects heightened doubts about whether the European Central Bank will raise interest rates again at its meeting next week.
Industrial production in Germany, the euro zone’s traditional growth engine, fell for a third straight month in July, data showed on Thursday. Meanwhile, the number of Americans filing new claims for jobless benefits unexpectedly fell, the latest sign of rejuvenation in the labor market. That could encourage the Federal Reserve to keep interest rates high for longer, boosting the dollar’s appeal.
“The U.S. data is relentless and comes amid very weak manufacturing in Europe,” said Chris Turner, head of FX strategy at ING. One rate hike is in doubt.”
Derivatives markets are implying around a 35% chance that the ECB will raise the deposit rate to 4% from 3.75% on Sept. 14.
That chance has declined following a string of weak economic data in recent weeks. Official second-quarter growth figures for the euro zone were revised down to 0.1 percent from 0.3 percent, with business surveys pointing to a further slowdown in August.
“It’s not good for the economy, it should lead to more deflation,” said Dirk Schumacher, a former ECB staffer and now an economist at Natixis.
He predicted the ECB would opt for a “hawkish pause”, meaning no rate hikes, but made it clear that it remained very concerned about inflation and was ready to return to tightening if price pressures became more stubborn. “This will make the market more wary than a rate hike, which investors will immediately think is the last rate hike,” Schumacher said.
Some investors believe that signs of a looming recession in Europe will make it difficult for the ECB to raise borrowing costs again, even if it sees the need to bring inflation down to its 2 percent target. Core inflation, which excludes volatile energy and food prices, remains well above the 5.3% target and is closely watched by the central bank.
“(Further rate hikes) could actually backfire because if they go into recession it means they’re going to have to cut rates further down the road,” said Tomasz Wieladek, chief European economist at T Rowe Price. “It’s a serious risk and I think they may have set themselves a trap, the recent numbers are unabashedly dovish.”
Further euro weakness could push up the cost of imports such as energy and food, complicating the ECB’s task of fighting inflation.
Rising oil prices after Saudi Arabia and Russia extended production cuts this week also added to inflationary pressures. Brent crude rose above $90 a barrel this week, its highest level since November.
Some investors are now talking about the euro area experiencing a period of stagflation – high inflation combined with stagnant economic growth.
“With euro area inflation still above average and growth well below average, the euro area is clearly suffering from stagflation by most definitions,” said Michael Metcalf, head of macro strategy at State Street Global Markets.
Investors expect the dollar to continue to rebound from a period of weakness earlier in the year, as a strong U.S. economy offers little incentive to cut U.S. interest rates anytime soon, which Federal Reserve Chairman Jerome Powell has been opposed to.
“There’s so much negative sentiment surrounding the dollar that I think it’s going to continue to resurface,” said Greg Peters, co-chief investment officer for fixed income at PGIM. “The core driver of interest rates remains growth.”
Investors expect the Fed may have finished raising rates, but traders are now betting the central bank won’t start cutting rates until the middle of next year. As recently as June, the swaps market was pricing in rate cuts before the end of the year.
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