The once resilient Euro-zone economy is slowly succumbing to the downward pressures of a strong euro, a slowing global economy and tight credit conditions. Looking ahead, I expect the EUR/USD to fall further and test 1.40 dollars per euro.

The once resilient Euro zone economy is slowly succumbing to the downward pressures of a strong Euro, a slowing global economy, high oil and food prices and tight credit conditions. In fact, in light of such risks, the IMF expects the world’s largest economy, according to 2007 GDP estimates, to grow at a very poor 1.7% pace in 2008 and 1.2% in 2009, compared to 2.6% in 2007. The main reason why the European Central Bank is not cutting rates already is because inflation is well above a level consistent with price stability and the central bank wants to avoid second-round effects of energy prices in wage and price setting. In fact, July CPI figures grew at a record pace of 4.1% and risks to price stability over the medium term remain on the upside, according to the European Central Bank president Jean-Claude Trichet.

EUR/USD Could Test 1.40 in 3 months

The euro has been very weak over the past month and I expect this down trend to continue going forward. To some extent the euro dollar up trend has been damaged by a significant shift of interest rate expectations in favor of rate cuts by the ECB and rate hikes by the Fed. In one hand, traders expect the Federal Reserve to increase rates by 75 bps over the next eight FOMC meetings, according to overnight index swaps traders. On the other hand, despite the fact that Jean Claude Trichet said he has no bias going into the next meeting, interest rate traders expect the ECB to cut rates by 50 bps in 2009. Looking ahead, I expect the EUR/USD to test 1.40 dollars per euro in 3 months.

Antonio Sousa is a Currency Analyst for FXCM.