After hitting a low near $1.30 in mid-March, the single currency steadily appreciated to end the month more than three cents higher. On Friday, the euro flirted with $1.34 on a boost to the euro zone's bailout lending limit, near the upper rung of the broad five-cent range in which it's been hemmed for most of 2012.
This strength comes despite weak growth throughout the 17-nation currency area, and just as government bond yields are rising in Spain, Italy and Portugal--all considered among Europe's most financially vulnerable economies.
When it renders its policy decision Wednesday, the ECB is widely expected to keep benchmark borrowing costs parked at their current rock-bottom levels. Because markets are still absorbing more than EUR1 trillion worth of liquidity issued to banks since December, the central bank is perceived to be reluctant to take additional policy steps.
While a banking crisis is no longer an immediate concern, analysts say the crosswinds of a sluggish European economy and a weakening China means the ECB may need to pull the trigger on lower borrowing costs sooner rather than later.
The ECB "avoided financial contagion by providing liquidity to banks, but they haven't been able to address growth prospects," said Andrew Busch, global foreign exchange strategist at BMO Capital Markets in Chicago. He thinks the central bank is likely to cut rates by the third quarter of this year.
Should the ECB deliver another rate cut, it would erode the yield advantage the euro enjoys over the dollar, weakening demand for the currency.
Helping lift the currency Friday, euro-area finance ministers agreed to temporarily boost the bloc's bailout lending limit to EUR700 billion tempering fears that Europe will be unable to manage a worsening of its debt crisis. Few, however, expect even that decision to cure what ails the euro zone's troubled economies in the long-term.
More evidence of Europe's weak economy may come in the form of February retail sales data and unemployment figures. Analysts at Barclays Capital expect unemployment to remain unchanged at 10.7%. A deterioration in those numbers could prompt more speculation about ECB easing, and put more pressure on the euro.
While a weaker euro would help the euro zone's export-reliant economy at a time when a recession in the 17-nation currency bloc is considered all but a certainty, according to economists, those in the market say growing bond yields are a bigger short-term worry. Immediate concerns have shifted from Italy to Spain, where the government is locked in a high-stakes battle to implement unpopular austerity measures and cut its budget deficit.
Accordingly, analysts will closely watch Germany, Spain and France as they tap bond markets next week, with the hope of extracting lower borrowing costs from investors. Economists at RBC estimate the three countries will issue a combined EUR14-16 billion worth of debt.
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