ECB UPDATE: Euro Rise Above $1.20 Seen Spurring 'Dovish' Taper

--Downward Pressure on Inflation From Rising Euro Complicates ECB Task

By Jack Duffy

     PARIS (MNI) - The euro vaulted above the $1.20 level for the first time

since January 2015 on Tuesday, presenting European Central Bank policy-makers

with a new challenge as they move to scale back their E2.3 trillion bond buying

program.

     The European currency pushed to a high of $1.2070, driven in part by North

Korea's latest missile launch, putting it up more than 7% since ECB President

Mario Draghi's late-June speech in Sintra, Portugal and nearly 15% since the

start of the year.

     With the ECB Governing Council meeting next Thursday to begin its QE exit

debate, the soaring euro presents a significant complication. Although most

analysts say the euro is not yet at the "pain threshold" that would hit Eurozone

growth and inflation, its current trajectory is cause for worry.

     "I think $1.20 is an important but mostly symbolic threshold," said Holger

Sandte, chief European analyst at Nordea Markets in Copenhagen. "But if you ask

me about $1.25, I would be worried and I think they should be worried as well,"

he said.

     Sandte and other analysts said Draghi erred in his Jackson Hole, Wyoming

speech on Friday by not even mentioning the euro, which markets interpreted as a

"green light" to push the currency higher.

     The key question is whether the downward inflation pressure from a stronger

euro will be offset by a more robust economic recovery. At the moment, analysts

expect new ECB staff inflation projections next week to show slight downward

revisions, with June's 1.3%  forecast for 2018 being cut to 1.1%, and the 1.6%

projection for 2019 trimmed to 1.5%.

     While inflation appears set to remain well below the ECB's near 2% target

possible through 2020, few expect the tapering process to be derailed by the

rising euro. ECB hawks like Ardo Hansson, governor of Estonia's central bank,

have argued that markets are pushing the euro higher simply because they are

more "upbeat' about the Eurozone economy.

     Other Governing Council officials, however, voiced concern at the July 20

policy meeting about a possible "overshooting" of the euro above levels

justified by economic fundamentals. The euro was then trading at around $1.1630.

Analysts say the rapid move above $1.20 will almost certainly add to the

sentiment on the council for a cautious QE taper. 

     "They know they will not get the euro dollar back down to $1.10 because

this will depend on U.S. action," said Carsten Brzeski, chief economist at

ING-DIBA in Frankfurt. "They want to taper so it will have to be a dovish

taper," he said.

     Brzeski said he expects the ECB to announce a reduction in QE bond buying

following its Oct. 26 policy meeting but to retain its "easing bias" or pledge

to ratchet up purchases if inflation takes a turn for the worse. He also expects

the ECB to broaden the assets it can buy, "to give markets the impression that

QE is still slightly open-ended." 

     Further euro appreciation from current levels could also lead to a

slower-than-expected monthly taper, with bond buying possibly extending beyond

2018.

     "If the euro is at $1.25 for the October meeting it becomes even more

difficult to justify tapering with the inflation outlook," said Nordea's Sandte.

--MNI Paris Bureau; tel: +33 1-42-71-55-41; email: jack.duffy@marketnews.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

[TOPICS: M$X$$$,M$$EC$]