Draghi Delivers: ECB To Spend At Least 1.1 Trillion Euro Fighting Deflation

January 22, 2015 • Trading Idea • Tags: ,

This article was originally posted on Forbes.com

The European Central Bank launched an expanded asset purchase program of 60 billion euro a month that will last from March 2015 until September 2016. In aggregate, the ECB’s asset purchasing program will be over 1.1 trillion euro, the high end of analyst expectations. The euro/U.S. dollar exchange rate is at $1.1530 (down 0.73%) on the news Thursday.

More Downside for Euro

The euro is at the lowest level it has been in the last 11 years after Draghi’s announcement. With the ECB essentially printing 60 billion euro each month, the value of the Euro is expected to depreciate further, potentially hitting parity levels not seen since 2002.

A weaker euro is in the EU’s best interest as it helps spur growth the Eurozone desperately needs. The ECB has already taken stimulative growth measures before this latest action by cutting interest rates to record lows, buying private sector assets and funneling cheap loans to banks. However, as seen below, GDP growth remains stagnant.

eurozone gdp growth rate

Running out of options, the ECB followed policies that the U.S. Federal Reserve, Bank of Japan and Bank of England have already used to revive growth. A depreciated euro should be helpful for Eurozone exporters, since European goods would be cheaper relative to other currencies, most notably the Japanese Yen and U.S. dollar. The ECB is also banking on the quantitative easing (QE) program to raise the inflation rate on the continent.

eurozone deflation

Data and Expectations Adding to Dollar Strength

Meanwhile, the U.S. economy added 1.7 million jobs in 2014 and is expected to expand by 2.6 percent during the year. This initial economic traction has influenced the Federal Reserve to potentially consider raising rates in 2015, making the U.S. the only major economy to consider such conduct. With the majority of developed economies struggling to find their footing, the greenback remains the safest bet in the currency market. Due to this, the dollar is expected to continue its ascent against weakening pairs, most notably the euro.

Writing on the Wall

Market participants were expecting this bond buying program and many took action to prepare. Last week the Swiss National Bank eliminated its euro floor on the Swiss franc, sending a panic across markets. Denmark, the last major currency to peg its currency to the Euro, saw its national bank cut interest rates deeper into negative territory (from -0.05% to -0.2%). Similar to the franc, investors have been attracted to the perceived safe assets, such as the Danish krone, to avoid the depreciating Euro currency.

Companies Impacted by Potential Parity

Any American multinational that has a significant portion of revenues derived from European operations will be a victim of a stronger dollar. International operations are translated back to U.S. currency, meaning the dollar’s appreciated value converts foreign currencies at a lower rate. For example, American cigarette manufacturer Philip Morris International has about 35% of its $30B in revenues coming from the European Union. When calculating earnings, Philip Morris must account for the currency loss of exchanging the depreciated Euro into the stronger USD. Other notable companies with significant European sales include McDonald’s and Coca-Cola.

USD/EUR Parity
Do you think USD / EUR exchange rate will hit parity?

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