The euro slid to a 20-year low against the US dollar as traders bet that the European Central Bank will go slower on raising interest rates as the economy risks being tipped into a recession.
The common currency fell as much as 1.4% to $1 0281, its weakest level since December 2002. The losses came as money markets trimmed ECB tightening bets after French services PMI was revised lower Tuesday, darkening the outlook for the region, which faces the prospect of gas shortages because of cuts in supplies from Russia.
The fallout from war in Ukraine is hampering the ECB’s ability to raise rates as fast as the Fed, despite record inflation, and widening the interest-rate differential. According to Bloomberg’s options-pricing model, there is now a 60% chance the currency hits parity versus the dollar by year-end, up from 46% on Monday.
“Parity is just a matter of time now,” said Neil Jones, head of FX sales to financial institutions at Mizuho.
Trader are betting the ECB will deliver around 140 basis points this year, down from more than 190 basis points almost three weeks ago. They expect policy makers will kick off their first tightening cycle in a decade later this month with a 25 basis points increase. The Fed has already raised rates by 150 basis points, with markets pricing in an 80% chance of a 75-basis-point hike at their July meeting.
“It is hard to find much positive to say about the EUR,” said Dominic Bunning, the head of European FX Research at HSBC, who expects the common currency to trade at parity with the dollar this year. “With ECB sticking to its line that we will only see a 25bp hike in July – at a time when others are hiking much faster – and waiting for September to deliver a faster tightening, there is also little support coming from higher yields.”
Investors have also been more cautious on the euro due to the risk of so-called fragmentation, when economically weaker nations see unwarranted spikes in borrowing costs as financial conditions tighten. The ECB is expected to deliver further details of a new tool to backstop more vulnerable countries’ debt at their policy meeting later this month.
The losses Tuesday were compounded by poor liquidity and selling in euro-Swiss franc, according to three Europe-based traders. The euro fell as much as 0.9% against the Swiss franc to 0.99257, the lowest level since 2015.
“The FX market is not back up to full liquidity given US holiday,” said Mizuho’s Jones. “Any given size of trade is likely to have a greater impact on market movement.”