LONDON (AFX) - The European Central Bank's decision to hold euro zone rates steady has dented theeuro, but the single currency's problems are more deep rooted, stemming from funds seeking better returnsoverseas, analysts said.
Flows will always gravitate towards markets and currencies perceived to yield the best returns and currentlythe U.S. is back in favour, said Halifax economist Steve Pearson.
The euro zone is also suffering from demographic factors, he said.
"It is a shrinking labour market and an ageing population. Expansion is always going to be faster elsewhere,"said Pearson.
The older the population, the more the need for investment. And investment means diversification, so moneyfrom Europe will continue to flow elsewhere, he said.
For the moment, the ECB's seeming inflexibility to take pre-emptive action to ward off the spillover effects ofa global slowdown has kept the speculative side of the market away from the euro, he noted.
HSBC economists agreed. The best analysis of the euro is done by examining flows, they said in a report.
The basic balance of payments, which includes portfolio investments, corporate activity and the currentaccount, has been negative in the euro zone, it added.
"It has not been matched by interest bearing inflows, thereby causing the euro to fall," HSBC said.
Given this backdrop, any ECB rate cut in the near future is unlikely to shore up the euro for very long, saidRazia Khan of Standard Chartered.
In any case, there are serious doubts whether this hoped-for rate cut will materialise, with the ECB clearlyindicating that it will not move unless euro zone data deteriorate significantly.
The ECB yesterday left interest rates unchanged, despite market expectations of an easing move.
"One lesson learnt yesterday is that the ECB will only react to considerations specific to the euroarea," UBSWarburg said in a research note.
Recent national inflation data point to a deceleration in headline euro zone inflation to around 2.5 pct in Marchfrom 2.6 pct in February. Taken in isolation, this data will not be enough to shift the ECB from the "wait andsee" stance it reiterated at yesterday's news conference, UBS Warburg said.
Ian Stannard of BNP Paribas said euro zone data will put the euro under pressure in the near term, especiallyfollowing disappointment on the ECB's decision not to ease rates yesterday.
"I would not be surprised if we saw the euro head back down to the 0.8810 usd level, perhaps even dippingbelow to the 0.8750 usd level," he added.
Adrian Schmidt, economist at Royal Bank of Scotland, said the argument between the ECB and the market isnot so much about different views over inflation but about future growth.
Schmidt believes that the ECB is not going to act unless some significant changes take place. He added that aslong as growth is expected to be in line with the trend rate of 2 to 2.5 pct over the next year or two, there isno real reason for the ECB to cut rates.
"We need to see some evidence that growth is not going to be at trend before the ECB is going to beconvinced to act. That could come from domestic data, weaker U.S. numbers or prospects of a weakerworld economy," he said.
Schmidt said that although the ECB does not have a target for the currency, its monetary policy reflects anassumption of what the currency will do.
Over the next month the euro is likely to be locked in a range of between around 0.87 usd and 0.90 usd, hesaid.
"They do not want it to fall too fast, because it is destabilising but they don't want it to rise too fast either," hesaid.
The ECB would probably be happy to see the euro remaining at this level for the next six months, hesaid.
---- by SIVAKUMAR SITHRAPUTHRAN and ANNE PEYRICHOU ----