(Bloomberg) — The euro’s charge toward a three-year high is stumbling as the European Central Bank quashes expectations that it’s anywhere near paring back emergency stimulus.

The ECB is increasingly expected by economists and investors to extend its elevated pace of emergency bond-buying at a June meeting, even as the continent’s vaccination program surges forward and the economy rebounds. That’s putting a damper on prospects for further gains in the common currency, which has risen about 4% against the dollar from a trough in March.

Policy makers including Executive Board member Fabio Panetta have signaled a willingness to shrug off near-term inflationary spikes and keep policy loose for the time being. On the other side of the Atlantic, counterparts at the Federal Reserve appear to have made peace with the need to eventually wind down their bond buying.

“For a significant rise in the euro I suspect we’ll need to see some hawkish noises from the ECB,” said Mike Riddell, portfolio manager at Allianz Global Investors. “But tapering aggressively puts the stability of the euro-zone bond market at risk, and rate hikes may never happen at all.”

Policy Shifts

Global central banks are quietly starting to tip-toe away from the emergency monetary settings put in place during the coronavirus crisis, and markets are reflecting slowing asset purchases and rate-hike expectations accordingly. The ECB, which has struggled for years with lackluster inflation, looks increasingly set to lag the pack — while the Fed could be next in line to deliver a hawkish surprise.

Traders are growing jittery at any hint of policy shifts. The pound spiked on Thursday after Bank of England policy maker Gertjan Vlieghe detailed several scenarios for the U.K. economy, including one where rates rise early next year if the labor market recovers smoothly.

Also this week, South Korea’s central bank Governor Lee Ju-yeol signaled a shift when he said officials are preparing for an “orderly” exit from record-low interest rates at some point as the economy recovers. Canada and New Zealand have also flagged such moves, while Federal Reserve officials have been steadily shifting their tone.

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Vice Chair Richard Clarida said he and his colleagues may be able to start discussing the timing for scaling back the Fed’s bond-buying program at upcoming policy meetings. Randal Quarles, the central bank’s vice chairman for supervision, noted that risks to inflation are skewed to the upside in the medium term, in part due to fiscal policy.

The diverging signals out of Washington and Frankfurt are prompting strategists from Rabobank and Credit Agricole SA to brace for the euro to decline by as much as 3% from current levels against the greenback.

Clashing Signals

Options markets show clashing signs. Risk reversals — a barometer of market positioning and sentiment — point to investor optimism on the euro. Implied volatility shows low expectations for the ECB’s next meeting in June.

While Allianz’s Riddell moved from a short euro position to neutral as the continent got its vaccine push on track, he says there’s little prospect of fresh impetus coming from the ECB, and faster inflation in the bloc is unlikely to last beyond this year.

The Fed, meanwhile, could bring up tapering at its Jackson Hole symposium in August, according to Jane Foley, Rabobank’s London-based head of FX strategy. That may trigger a dip to 1.18 against the dollar for the euro, she said. The currency closed at 1.2188 on Friday.

A drop like that could wrong-foot investors: asset managers’ net long positions on the euro climbed this month to the highest since at least 2006, according to CFTC data.

ECB officials fear a stronger euro could harm the still-fragile European recovery, and say they’re keeping an eye on the currency. Wage pressures are weaker in the euro zone and the recovery isn’t as broad-based as in the U.S., according to Jonathan Peterson, markets economist at Capital Economics, factors which will likely weigh on the common currency.

At the same time, bond markets are projecting European normalization, with yields expected to turn positive as the continent proceeds with vaccines and reopening.

Most of the increases in German borrowing costs reflect a pickup in domestic demand and the expectation it will continue, according to Bloomberg Economics. Growth estimates from economists surveyed by Bloomberg show more room for upside in the euro zone compared with the U.S.

And some analysts, including those at Deutsche Bank AG, Citigroup Inc. and Bloomberg Intelligence, still see the euro reaching $1.25 or higher in the coming months. George Saravelos, global head of FX research at Deutsche Bank, predicts further upside if the region’s data continue to strengthen. A Fed announcement on tapering might not be interpreted as a hawkish signal, he said.

Even so, the rise of coronavirus variants remains a threat to the region’s economy, and history shows the ECB proceeds more cautiously than the Fed.

“When you look at expectations in the United States and expectations in the euro area, we are not on the same page,” ECB President Christine Lagarde said in April. “It would clearly predicate that we will not operate in tandem with the Fed. I think that’s very much a given — it’s not me looking into a crystal ball.”

Next Week

European government bond supply will see Germany, France, Spain and Belgium sell about 20 billion euros of debt ($24.3 billion) according to Citigroup Inc.The U.K. will sell 10- and 25-year gilts for 4.75 billion poundsScheduled ECB policymaker speeches are light ahead of the quiet period which begins Thursday ahead of the following week’s policy decision; BOE Governor Andrew Bailey speaks twiceOn the data front, euro-area and German inflation numbers are expected to take the limelightU.S. and U.K. markets are closed Monday for holidays

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