Forex week ahead: A Tale Of Two Central Banks...

-By Javier E. David, article originally appeared on WSJ

--ECB, Fed take center stage in busy week

--Dollar most vulnerable to Fed decision; wisps of QE3 talk

--New ECB chief may hint at lower rates amid debt woes

NEW YORK -(Dow Jones)- Both the dollar and euro are vulnerable to monetary policy decisions in the coming week, although the Federal Reserve poses a bigger risk to the greenback than the European Central Bank does to the common currency.

A blitz of data and policy meetings await investors, including reads on global manufacturing and the all-important U.S. payrolls figure. And summit fatigue notwithstanding, the Group of 20 developed and developing nations will meet in France to discuss the global economy and address the plan that euro zone leaders unveiled in the past week to solve their region's sovereign debt crisis.

New ECB President Mario Draghi will convene his first policy meeting, which some believe could mark the beginning of a campaign to lower borrowing costs in the euro zone as it faces the double-barreled threats of weak growth and the debt situation. That could cut the yield advantage enjoyed by the euro, which in the wake of market euphoria over the European debt accord surged to a seven-week high at $1.4248.

Yet it is the Fed, which will make a policy decision Wednesday after having begun a new attempt to push down long-term interest rates at its last meeting, that poses the most nettlesome challenge to the dollar. A clutch of Fed officials have recently stoked speculation that a third round of quantitative easing, or QE3, could be on the way. A recent Wall Street Journal report suggested the Fed may channel its bond-buying from Treasurys into mortgage-backed securities to help jolt the economy. That could have the same damping effect on the dollar that the previous QE2 round had.

Fed Chairman Ben Bernanke "is very much committed to maintaining ultra-accommodative monetary policy to help support refinancing at low interest rates. The benefits of this outweigh the risks of inflation," said Michael Woolfolk, currency strategist at Bank of New York Mellon.

The majority of the Fed's Open Market Committee feel "comfortable following [Bernanke's] lead," Woolfolk says. "So we can essentially ignore inflation reports for the foreseeable future until further notice."

In combination with Europe's landmark deal to reduce Greece's debt load, the suggestion of more monetary stimulus conspired to drag the ICE Dollar Index to its deepest trough in nearly two months this week. The greenback's woes could deepen if the Fed mentions more easing beyond the so-called Operation Twist, its newly launched $400 billion effort to push down long-term interest rates by shifting its assets holdings out of short-dated securities into bonds with longer maturities.

And even if the central bank doesn't explicitly raise the curtain on new easing right away, U.S. interest rates--currently among the lowest in developed economies--are a drag on the dollar. That's especially so now that global investors have rediscovered their appetite for higher returns, thanks to improved economic data and the momentary respite in the euro-zone crisis.

That said, the ECB's policy decision could provide unpleasant surprises for the euro.

As Greece's debt woes have rocked markets worldwide, data in the euro zone have done a slow fade, leading some analysts to believe the ECB will lay the foundations for a cut in borrowing costs even as it aggressively buys bonds to support distressed euro-zone sovereign debt.

With Draghi taking the helm after the departure of Jean-Claude Trichet, some believe the timing is right for the ECB to shift course from its traditional emphasis on inflation. Indeed, dovish Bank of England Monetary Policy Committee member Adam Posen, speaking at a conference in New York this week, chided the ECB for the "virginal purity" that prevents it from taking more aggressive steps to jumpstart growth as Europe's economic outlook darkens.

"In a month we'll have seen the dirty underbelly" of the euro zone's economy, said Tommy Molloy, chief dealer at FX Solutions, which is likely to force the ECB's hand. "What happens if a 50% haircut is not enough to get Greece back on its feet? And what happens if Europe goes into a recession?"