For “risk-on, risk-off”, you could read “referendum-on, referendum-off“ on Thursday. Yet, for all the turmoil in the eurozone – and an unexpected interest rate cut by the European Central Bank – it is actually the US dollar, rather then the euro, that looks the more vulnerable of the two currencies.

With both the ECB and the Federal Reserve looking to extend support for the US and European economies amid growing fears about another slide into recession, strategists say the prospect of further monetary easing by the Fed in the new year would weigh heavily on the dollar.

Though the US currency has rebounded from its lows in August, helped in part by Japanese action to weaken the yen and the Swiss National Bank trying to forestall further appreciation of the franc, it remains a laggard in terms of its performance this year.

“We have frequently described the foreign exchange markets as an ugly parade and the US dollar has by no means relinquished its title,” says Neil Mellor, currency strategist at BNY Mellon.

The reaction to Thursday’s quarter point cut in interest rates by the ECB supports this view. As stocks gyrated on political turmoil in Greece, there was only limited selling of the euro after the central bank decision. Mario Draghi, the new ECB president, warned that the region faces a “mild recession”, yet the single currency held its ground above $1.38 against the dollar.

Dollar

That interplay in the world’s most actively traded currency relationship underlines how the twists and turns in the eurozone’s sovereign debt crisis are being played out primarily in bond markets and not in foreign exchange.

“The eurozone crisis is not really about the currency, it’s more a reflection of the internal imbalances between countries such as Germany and members of the periphery,” says Paul Robinson, global head of FX research at Barclays Capital.

As it stands the dollar has fallen more than 3 per cent against the euro so far this year. On a trade-weighted basis against its six major partners, the dollar index is 3 per cent lower.

For all its apparent attractions as a relative haven, the US currency’s failure to derive a bigger bounce from the eurozone debt crisis reflects in part how its prospects are determined by a central bank that is required to balance a dual commitment to maintaining stable prices and maximum employment.

“The primary negative of the dollar is that it has a central bank willing to pursue unorthodox policy and, while that won’t stop dollar appreciation, it does explain why the euro has not sold off more,” says Alan Ruskin, strategist at Deutsche Bank.

On Wednesday, after the Fed kept overnight rates anchored near zero per cent, Ben Bernanke, its chairman, told a press conference that further purchases of mortgage-backed securities – a form of additional quantitative easing – was a “viable option” should the economy require further help.

And, rather than duck the question, Mr Bernanke fanned sentiment in the market that a third wave of “QE” was likely. The prospect of quantitative easing has in the past undermined the dollar. The flood of cheap Fed money is seen as supportive of risky assets, reducing the dollar’s haven appeal and adding to the risk of an inflationary surge later.

“Additional Fed policy [easing] would be substantially US dollar negative,” says David Woo, head of global rates and currencies research at Bank of America Merrill Lynch.

A recession in Europe, together with a slowdown in emerging markets, would not help the US economy recover more quickly, moreover. So long as America limps along at its current lacklustre pace, the Fed will want to leave open the possibility of launching another round of QE.

Some analysts argue the euro is set to weaken. But few expect the single currency to test the low of $1.19, hit when Greece’s debt problems erupted in 2010. “We expect the euro will fall towards $1.30 over the next three months,” says Mr Robinson.

A fall to the $1.30 level would only return the euro to this year’s low recorded in January.

Mr Woo says sovereign debt worries as well as ECB rate cuts will weigh on the euro, but the bank is maintaining a 2012 year-end target of $1.40. This is based on the prospect of the Fed starting QE3 while emerging market economies continue to diversify out of dollars.

For the single currency to suffer a serious breakdown, Mr Ruskin says: “You need to see a rupture of the eurozone core that results in capital flows leaving the euro.” Not impossible, but not yet regarded as the most probable outcome.

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