Draghin down the euro

A weakening euro is good news for ECB President Mario Draghi, particularly if it spurs some much-needed inflation, while the greeenback continues to rally on the back of the Fed's interest rate outlook.

As the US dollar rally starts to gather momentum, the euro is approaching its lowest levels in almost a year.

Divergence between the FOMC and ECB interest rate outlooks has been the main driver behind the move that has seen the euro fall 6 per cent since early May. The wedge between the two is only getting wider, with comments from both US Federal Reserve Bank chair Janet Yellen and European Central Bank president Mario Draghi dragging the euro lower over the weekend.

Change of tone in the US

Most of the focus from the Jackson Hole symposium over the weekend has been on remarks made by Janet Yellen. Her comments on the North American economy appear more neutral than hawkish as some have suggested.

They are, however, less dovish as the market has come to expect, and it was a reference to interest rate hikes potentially coming “sooner than market participants currently expect” that sparked a flurry of demand for the greenback. Although the timing on US interest rates is unclear, Yellen’s tone is to be expected, especially from a central bank edging very slowly towards monetary policy tightening.

Economic data takes centre stage

Looking beyond the headlines, it is clear there are still some considerable risks ahead for the US economy. The Fed is looking at much more than just the unemployment rate for a reading on the employment market.

This week sees a number of market-sensitive economic data releases including new home sales, durable goods, unemployment claims and preliminary GDP. Positive news is likely to be met with more USD buying, however if key data such as durable goods and GDP (expecting 3.9 per cent vs 4 per cent last) fall short of expectations, then the big dollar could spark some selling by profit takers. 

Graph for Draghin down the euro

ECB joy at weaker Euro

ECB President Mario Draghi would be happy the euro is weakening and nearing 12-month lows against the greenback as it could help spur some inflation. Given he signalled the central bank's readiness to act further to halt a continuing decline in eurozone inflation, any squeeze higher in the euro is likely to be short-lived.

This is because further expansion of monetary policy would only serve to weaken the currency even more. With the release of European CPI flash estimate due Friday, a test of the key 1.31 level against the greenback seems imminent. But a bounce back towards 1.33 cannot be ruled out as the major downtrend continues towards 1.2750.

Jim Vrondas is chief currency strategist, Asia-Pacific at OzForex, a global provider of online international payment services and a key provider of Forex news. OzForex Group Limited, is a publicly listed entity with shares traded on the Australian Securities Exchange under the code "OFX".