The euro erased earlier gains and fell across the board on Tuesday after European Central Bank chief Mario Draghi said policymakers will provide more stimulus if inflation does not pick up.
At a speech in Sintra, Draghi said the ECB could still cut rates, adjust its guidance, offer mitigating measures to counter the unwanted side effects of negative rates, and also had “considerable headroom” for more asset purchases.
“That is twice in less than two weeks he has warned about the risks to price stability but today we got the clearest hint that a rate cut and/or QE2 could happen,” said Kenneth Broux, a currency strategist at Societe Generale in London.
“Draghi’s words that the council will deliberate ‘in the coming weeks’ is implicitly a reference to the next council meeting in July or September.”
Against the dollar, the euro fell as much as 0.3 percent to a two-week low of $1.1182. It dived to a 1-1/2 week low versus the Swiss franc too
With benchmark euro zone interest rates already in negative territory and inflation expectations well below central bank forecasts, markets perceived Draghi’s comments as quite dovish.
Money markets are now pricing in one full rate cut of 10 basis points by the end of the year with core bond yields across the eurozone falling 5-10 basis points across the board.
Themos Fiotakis, head of FX and rates strategy at UBS, said the main risk from Draghi’s perspective is a stronger euro weighing further on inflation expectations.
“So whatever the Fed outcome tomorrow, the ECB does need to fend off the notion that there is a lot more space to ease in other economies,” Fiotakis said, referring to the Fed policy decision on Wednesday.
The euro’s weakness propped up the dollar against a basket of its rivals before a U.S. central bank meeting got underway with expectations growing the Fed will signal its first rate cut in a decade.
A CME Fedwatch tool puts the probability of a quarter-point interest rate cut by the Fed at 20%, with a 70% probability of a rate cut at its next meeting in July.
But with so much dovishness already priced into the markets and the dollar having weakened 1% over the past three weeks, some market analysts say the greenback may strengthen if the Fed signals a more neutral stance.
“The majority view among the Fed comments does not suggest any particular appetite for an immediate rate cut, say in June or July,” HSBC strategists said in a note. “The balance of risks favours being long the dollar, not least because positioning is likely a little lighter after the recent sell-off.”
Against a basket of its rivals, the dollar edged 0.2% up at 97.70, moving further away from a three-month low of 96.46 hit earlier this month.