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U.S. Dollar to Extend Gains as ECB Nears Quantitative Easing

Stocks in this article: UUP

NEW YORK (TheStreet) -- PowerShares DB US Dollar Index Bullish  (UUP) may extend gains over the next year as a weakening European economy could lead the way to more aggressive stimulus by the European Central Bank.

The ECB left interest rates unchanged on Thursday, which was expected after the broad range of policy enacted in June.

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During the June meeting, ECB President Mario Draghi made the bold move of taking the deposit rate below zero and announcing a new round of long-term loans for banks that will be tied to lending to smaller companies. These efforts hoped to combat deflation and a euro area economy that continues to sputter.

Unexpected declines in European economic data this week, however, reveal that more aggressive policy may still be down the road. Italy's growth figure unexpectedly shrank in the second quarter, falling back into recession and a slump that has lasted most of the past three years.

Italy's gross domestic product fell 0.2% from the previous three months when it forecast expanding at a 0.1% pace, according to a Bloomberg survey. Meanwhile, German industrial production rose less than estimated in June. Factory production in Germany increased 0.3% on the month, compared to consensus estimates of a 1.3% increase.

Compounding weakness in two of the euro areas largest countries gives credence to Draghi's statement on Thursday that more unconventional plans are in the coffers.

"Moreover the (ECB) governing council is unanimous in its commitment to also using unconventional instruments within its mandate should it become necessary to further address risks of too prolonged a period of low inflation," Draghi stated.

Analysts believe that full-blown quantitative easing, or the outright purchasing of bonds and other assets to stimulate the economy, will be put into place by the ECB over the next year. This should lead to further declines in the euro, and support the U.S. dollar as euro trade accounts for close to 57% of the index.

A survey of 61 foreign exchange strategists done by Reuters this week, shows that the euro is expected to decline to $1.28 in 12 months. This represents a 4% decline from current levels, and would place the exchange rate near 2013 lows.

Read More: How Facebook Has a Huge Opportunity in China

Ultimately, investors expect the Federal Reserve to begin tightening policy soon, while simultaneously waiting for the ECB to become more aggressive in its stimulus, which should continue to fuel declines in the euro/dollar currency pair.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

Follow @macroinsights

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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