Trade-weighted euro may be set for shock upswing in 2015

• Yuan, more important for euro than dollar, could weaken
• Yen, sterling, also vulnerable against euro in 2015
• Current account surplus to underpin common currency

LONDON (Reuters): While investors are betting the euro will fall against the dollar next year, hopes that the European economy will therefore get a boost could be premature: it may not depreciate at all against currencies of other major trading partners. As speculation grows that the European Central Bank will ease monetary policy more aggressively, some economists predict the euro could even slide to parity with the dollar by the end of 2015 from around $1.22 now. However, the dollar is no longer the most important element in the ECB’s trade-weighted euro index, its favoured gauge of the euro’s strength. That position is now held by the yuan and against the Chinese currency -- along with others such as sterling, the Swiss franc and Japanese yen – the euro’s prospects are far from clear. The euro has already lost around 3% against the dollar since early October when the ECB said it would buy rebundled packets of debt, as it tries to fight off the threat of deflation in the euro zone. Expectations are strong that the ECB will move on to quantitative easing next year by buying government bonds. This would involve printing money in the hope of pushing inflation that is close to zero towards its target of just under 2%, a policy that should weaken the euro. The ECB reckons that a 10% fall in the euro’s effective exchange rate would deliver 40 to 50 basis points of much-needed inflation to the euro zone. However, the euro has actually gained around a third of a percent on a trade-weighted basis since October. China is now the euro zone’s biggest trading partner, and the common currency has held steady against the yuan over the past month while it has fallen 1.5% against the dollar. Any euro rise against the yuan would effectively import disinflation from China, hurting the ECB in its campaign to avoid the kind of deflation that has hit the Japanese economy so badly in the past decade.