The euro is set for further losses despite a veiled warning from the European Central Bank that it could step up to full-scale intervention.
The ECB announced it would buy €250 billion (£197 billion) yesterday in what has been described as "quasi-intervention". However, the move only boosted the currency for a matter of hours before it once more headed south.
At a press conference yesterday, ECB president Mr Wim Duisenberg denied the currency purchases amounted to intervention, insisting that the bank was merely using the interest it has earned on its deposits since January 1999. But he admitted to feeling pleased about the effect it had on the exchange rate.
"I was not disappointed by the market reaction. It was not motivated to damage the euro." Mr Duisenberg said the ECB would repeat the exercise regularly, a remark that led some market analysts to conclude that the bank is preparing for a full-scale intervention. However, the market was extremely sceptical. This marks the first time the bank has stepped into the market to defend the currency's value in its 20-month history. "It's a dangerous move," said Mr Peter Saacke, an economist at Merrill Lynch in London, adding that the effect could wear off in a few days and the euro may test new lows again, damaging ECB credibility.
Indeed, when it became clear that no support would be forthcoming from either the US Federal Reserve or the Bank of Japan the euro fell again. In late trading it was at $0.8620, below the closing level a day earlier of $0.8643. However, it had risen as high as $0.8738 when the purchases took the market by surprise. The timing suggested that the ECB may want to put a floor of 85 to 86 cents under the currency.
Mr John Beggs, chief economist at AIB, warned that the markets would now begin testing the ECB's resolve. However, without US and Japanese support, something that is unlikely to happen before the US elections in November, he predicted that the currency is likely to fall to $0.80 within a week or two.
After that it was possible that disorderly market conditions could persuade the other central banks to bail out the ECB, he added. As a result the pound is likely to fall to 72p or 73p against sterling and to almost parity against the dollar, he warned.
"We should be extremely concerned with the euro at these levels. There is a very serious risk that this could push inflation even higher than the 7 per cent peak already expected. And it increases the risk of a wage price spiral," he warned.
Mr Beggs added that the ECB will find it very difficult to overturn the trend.
Even news yesterday that euro zone GDP grew by 0.9 per cent in the second three months of the year and by 3.8 per cent year on year failed to boost the currency.
"We need to have a series of negative announcements coming from the US for the euro to start to benefit. Although if that does happen and the market focuses on the massive US balance of trade deficit, the dollar could sink very quickly."
