By Naomi Rovnick and Dara Ranasinghe
LONDON (Reuters) – Traders kept the euro on track for a strong comeback on Thursday as the European Central Bank’s dovish stance after a second interest rate cut in September took concerns about French policy off the currency’s path.
As global markets brace for a rapid cut in U.S. interest rates, the European Central Bank signaled growing concerns about volatile inflation, helping to sustain a bullish turn for the euro that is nearing four-month highs after being rocked by French government unrest in June.
The European Central Bank left its deposit rate unchanged at 3.75% after cutting it from 4% in June for the first time in five years, with bank president Christine Lagarde stressing that the bank was not committed to a particular interest rate path.
In contrast, Federal Reserve Chairman Jerome Powell said on Monday that he was more confident that U.S. inflation had already eased.
That has helped, at least temporarily, boost the euro, which is up more than 2% against the dollar so far this month after falling about 1% in June.
The euro was trading at around $1.093 on Thursday, down slightly on the day but still on track for its biggest monthly jump since November.
“The extreme scenarios surrounding political risks in France are starting to recede, markets are convinced that the Fed will cut rates soon and we are starting to see the dollar weaken against most currencies,” said Bill Papadakis, a strategist at Lombard Odier.
But the euro has fallen against the Swiss franc and the pound this month. Investors have warned that the euro is not a straightforward bet if Donald Trump wins the U.S. presidential election in November. Trump has proposed imposing tariffs on imports that would hurt the eurozone economy, boost U.S. inflation and push up U.S. interest rates and the dollar.
“We expect the interest rate differential between the eurozone and the US to narrow, which should lead to some depreciation of the dollar,” said Amelie Derambouri, multi-asset portfolio manager at Amundi.
“But markets view a Trump win as a bullish event for the dollar, so the decline in its value will be limited until the election.”
Is the return of the currency guaranteed?
Financial markets are pricing in more than two rate cuts from the Federal Reserve by the end of the year, and just under two from the European Central Bank.
The dollar has held up well against most of its rivals for most of last year, but it has begun to see its value fall as support for interest rates fades. The index, which measures the dollar’s value against major currencies, is down 2% so far in July.
Meanwhile, the euro has recovered from its June slump, when it hit a two-month low against the dollar, as French President Emmanuel Macron’s snap parliamentary election unleashed political instability at the heart of the eurozone and drew attention to France’s large budget deficit.
The prospect of eurozone members clashing over a French fiscal emergency in June has brought back memories of past eurozone sovereign debt crises, which pushed the single currency project to the brink of collapse.
But that fear is fading, as the extra yield traders demand to hold French 10-year bonds over German ones has now risen to about 65 basis points, after briefly rising to a 14-year high of 85 basis points in June.
“Our view is that the (ECB) will cut rates in September and again in the fourth quarter, but they are in a slow cycle of rate cuts,” said David Zahn, head of European fixed income at Franklin Templeton.
Slowdown risks
Lagarde indicated on Thursday that she is concerned about eurozone growth in the context of potential global trade wars.
Trump’s pledge to raise import tariffs poses a major risk to the single currency area’s export-focused economy, said Benjamin Millman, chief investment officer at Edmond de Rothschild Asset Management.
“China is at the forefront because it has more political impact, but Europe could also be an easy target,” he added.
Millman expects the ECB’s deposit rate to be no more than 2.5% by the end of 2025, and is bullish on short-term government bonds, which benefit from expectations of lower interest rates.
Konstantin Veit, portfolio manager at Pimco Bond Fund, said he did not see any major moves in the euro against the dollar as of now.
“They (ECB policymakers) are in no hurry.”
