By Gavin Friend
London, May 25 (BridgeNews) - The euro's slide on the foreign exchanges this week has taken it well below levels against the U.S dollar at which the European Central Bank instigated G7 and then unilateral intervention in support of the euro late last year.
The current decline has naturally prompted speculation that the bank might be preparing to step into the market once again. While a range of factors this time around suggests that for the moment at least, the time is not right, some analysts caution against ruling out official action should the risks of a disorderly market become a bigger threat.
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The ECB has no exchange rate target and instead focuses on price stability.
Therefore, while G7 communiques maintain that exchange rates should reflect economic fundamentals--a possibly contentious point for the ECB at the moment--any intervention would by implication mean the bank is suitably concerned about prices.
"Their only mandate to intervene is if price stability is threatened," said Claudio Piron, currency strategist at Standard Chartered Bank in London,
But coming so soon after the ECB cut rates on May 10, intervention now would likely raise further questions of credibility with the market. ECB credibility did take a knock by the timing of the May rate cut which came despite clear signals from the bank that cuts were not on the agenda at that stage.
At $0.8550, the euro is just over 3% lower versus the dollar since the rate move, but less so on a trade-weighted basis. Oil has also pushed higher since the rate cut, increasing price pressures further, but not measurably so. Brent crude prices for June rose to a 6-month high of around $29.6 per barrel this week, but have since eased back to roughly the same level as when the bank cut rates.
Tony Norfield, global head of foreign exchange research at ABN Amro in London disagrees with the generally accepted view that the ECB will only intervene to protect price stability. Norfield said that while he thought the ECB's credibility was "shot anyway," to do anything about the rise in import prices via the exchange rate would take a rise in the value of the euro by around 20%--something that just won't happen.
"I disagree with the simplistic logic that a lot of people are following s here," he said. "The logic behind intervention is only to stabilize the financial markets and for that reason they may want to do it (intervene) if the euro takes another lurch lower."
Norfield argues that if the euro's decline continues to say "somewhere around or below the $0.8400 level, that would get the panic button's pressed" with some of the longer-term investors. Already under water with long positions these investors might then start to think that the next move would be to $0.8000 very quickly and then into the $0.7000s, according to Norfield. From that point of view, he said "it would make sense for the ECB to intervene," and prevent such a wash-out. But Norfield conceded that it "was not a good time to do it right now," as the readings for speculative market positions do not support the ECB getting much of a euro bounce for their money. A decline to the $0.8400 area, however, would probably be consistent with oversold readings coming through, he said.
Another reason why the ECB might be reluctant to intervene at the current stage is the bigger picture and the reasons behind the current euro weakness, which suggest to many traders and analysts that current euro losses are not of a temporary nature.
The latest slide in the German Ifo business climate index was widely attributed as the key factor behind the euro's latest plunge. But that index was more likely a necessary catalyst. The groundwork for the euro's slide was prepared over the previous week via a boost to confidence in the U.S. recovery following the Federal Reserve's latest 50 basis point rate cut, the 5th this year.
The FOMC's accompanying statement which, contrary to broader market opinion at that time, suggested the Fed might well cut again gave a real boost to confidence. While the reaction was not instantaneous, the boost was sufficient to push U.S. stocks higher, giving the Dow the support it needed to push up through the 11,000 level and into higher territory. In turn this allowed the dollar to break out of its broad 2-month ranges versus the euro and the Swiss franc, also up into higher ground. Against a background of increased confidence in the U.S. economy, any negative news on the European growth front is and will continue to be taken negatively.
Taking this into account it could be argued once again that any official intervention will only have a limited effect. Aside from evidence from the various fund manager surveys that show longer-term investors are still harbouring long positions and may use any intervention inspired euro rallies to exit these positions, the ECB will also be mindful of signs of a pick up in M&A related sales of euros.
Moreover, last weekend's adjustments to the MSCI stock index weightings all adds support to the theory that intervening now might not be the best way of spending the Eurosystem's FX reserves. Kamal Sharma a currency strategist at Commerzbank in London believes that against the backdrop of a continuing decline in economic indicators in the euro zone, the ECB will not be hasty in choking off any nascent export boost to GDP via the lower exchange rate.
Pointing to a decline in German foreign factory orders data as one example of declining demand in the euro zone's largest economy, Sharma said "a weaker euro will help those foreign orders". "On this basis I can't see the ECB intervening imminently".
Other market observers believe there is a chance of the ECB joining forces with the Bank of Japan and intervening on euro/yen. The combination of long euro and short yen positions on the IMM and within the wider market place have also seen sharp falls in the euro/yen and dollar/yen exchange rates over the last few days.
While euro/dollar was down just over 4% on the week at one stage, euro yen was down over 7%, before a minor recovery. Meanwhile dollar/yen was also down po around 4% over the same time period. The yen's sharp gains, which are mainly position related, prompted the vice minister for international affairs at the Japanese Ministry of Finance, Haruhiko Kuroda to say Thursday that the euro's steep fall was inappropriate as was the decline in dollar/yen.
Kuroda said the Japanese MOF would monitor the moves and take appropriate action if unnatural FX moves continue. This, together with more jawboning from other officials, including Kuroda's predecessor Eisuke Sakakibara, have managed to put a base under euro/yen and dollar/yen for now. But both remain vulnerable to further losses.
The still mildly influential Sakakibara said he didn't think the yen would move outside of its recent range--suggesting the aforementioned moves would not go much further.
According to some analysts, officials are likely to increase the verbal warnings before actually entering the market. And while Japanese rhetoric is likely to increase in the following days, it is noticeable that ECB has been more or less silent on the euro so far.
With this in mind a London and New York free Monday might spark a move on the euro in reaction to ECB president Wim Duisenberg's testimony to the European Parliament's Economic and Monetary Affairs Committee in Brussels. Should Duisenberg decide that a few choice words could give the euro a lift, the thinness of the market might see something of a rebound. On the other side, a failure to talk the euro up is likely to be taken negatively and may well lead to more follow-through sales, especially when London returns on Tuesday.
Claudio Piron reckons the critical point for the euro as far as the ECB is concerned might be that they feel after "successfully" instilling some two-way risk in the euro by intervening last year, some of this risk is still there--especially given the respective short-term yield differentials and relative economic growth outlooks.
But as he warns, "the thing that always freaks me about the ECB is they're too unpredictable. Given the timing of the rate cut, you can "never say never with those guys."

Gavin Friend, Bridge News, Tel: +44 20 7842 4185
Send comments to Internet address: forex@bridge.com