* Euro's rise towards $1.45 may push ECB to change stance
* Options indicate market less bearish towards euro
* Inflows to euro zone eyed as money mkt rates climb
By Anirban Nag
LONDON, March 10 The European Central Bank's
decision to leave monetary policy unchanged, and its seemingly
relaxed attitude to the impact of a strong euro on deflation,
may have put the single currency on course to reach its highest
levels in nearly three years.
If the euro zone economy shows more signs of recovery in
coming months and U.S. data remains patchy, the euro could rise
towards $1.45 - a level seen in mid-2011 - before the ECB
expresses discomfort with the exchange rate.
ECB President Mario Draghi suggested at a news conference
after last Thursday's Governing Council meeting that economic
recovery in the euro zone was on track and did not require a
shift in monetary policy.
His comments sent the euro to a 2 1/2 year high of
$1.3915 and analysts expect the currency to rise initially to
$1.40 in coming weeks.
Although one ECB policymaker, Christian Noyer, expressed
some unhappiness about the euro on Monday, investors are likely
to test the ECB's resolve to keep monetary policy unchanged by
adding to long bets on the euro.
"We would not want to go short on the euro and do not rule
out a move to $1.40 in the near term given the ECB's stance,"
said Yujiro Gato, G10 currency strategist at Nomura in London.
"But only a move up towards $1.45 would change the ECB's
The euro has gained 15 percent against the dollar from 2012
lows as the threat of a euro zone break-up waned and the
region's economy has started to pull out of its slump.
However, while a sharply rising currency adds to the risk of
deflation in the euro zone, as it lowers prices of imported
goods, Draghi said on Thursday that the currency's rise since
2012 lows had pushed down inflation by only 0.4 percentage
That has led some analysts to believe the central bank could
tolerate the euro strengthening by another 5 percent - to around
$1.45 - at which point it would probably be forced to take
action to ease policy to boost prices.
"It appears the FX market found Draghi's comments more
hawkish than the rates markets did," said Anthony O'Brien, an
interest rate strategist at Morgan Stanley.
Draghi's "rule of thumb" comments that "each 10 percent
permanent effective exchange rate appreciation lowers inflation
by around 40 to 50 basis points," could give the euro a 3-5
percent lift, he said.
After that, the ECB would become concerned about the euro's
impact on inflation and consider cutting interest rates. A cut
in the deposit rate, now at zero, into negative territory, would
have the biggest impact on the euro, analysts say.
SHRINKING BALANCE SHEET
"The ECB is incredibly relaxed about inflation and that
means only one thing for the euro - up," said Howard Jones, a
partner at RMG Wealth Manager, who does not rule out a move
above $1.40, though a lot would depend on U.S. data.
In the options market, risk reversals - a gauge of demand
for options betting on a currency rising or falling -
, show a lesser bias for a weaker euro against the
dollar in the coming four weeks.
Speculators added to bullish bets on the euro in the week to
March 4, data from the Commodity Futures Trading Commission
shows. But such bets are far fewer than when the euro last rose
above $1.45 three years ago.
An unexpected decline in inflation in coming months, or a
sudden deterioration in economic data, would pose risks to the
Annual inflation in the euro zone stabilised in February at
0.8 percent but Draghi warned last week that it was still "way
below" the central bank's target of just below 2 percent.
For now, though, policy easing bets are being scaled back.
"The ECB's utter inaction leaves investors to seriously
question an assumption that policy easing will be forthcoming.
If it is not, bearish euro views are subject to revision," said
Tom Levinson, currency strategist at ING.
Euro zone banks meanwhile are repaying cheap loans taken
from the ECB in late 2011 and early 2012 at the height of the
debt crisis. That is likely to reduce excess liquidity in the
banking system and push short-term market rates
higher, making the euro even more attractive
The euro's gains accelerated late last week after data from
the ECB showed banks were set to repay a big chunk of their
emergency three-year loans. That will shrink the ECB's balance
sheet just as the U.S. Federal Reserve and the Bank of Japan are
expanding theirs by buying bonds, giving investors another
reason to buy the euro.
According to a Morgan Stanley analysis, a rise in euro zone
money market rates does attract inflows and broadly underpins
the euro, which on a trade-weighted basis is
trading near its highest level since early November 2011.
Manuel Oliveri a strategist at Credit Agricole, expects the
euro to rise to $1.40 and possibly beyond in the near term.
"Draghi more or less indicated that there is no imminent
need for additional policy action. This is especially true as
medium-term inflation forecasts remain close to target," he