In all, EUR will continue to reign supreme in the absence of any evidence that the ECB is worrying about the impact of the FX appreciation on the economic outlook”
ECB exchange rate impact
Above: Benoît-Cœuré, (c) ECB.
This is something of a purple patch for the Euro – the currency is 2017’s undisputed king with advances being registered against all its ten major competitors with a whopping 8.56% advance coming against the Dollar and a 4.06% gain being registered against Sterling.
For those wondering what the future holds, I would say that based on momentum alone it would be wise to expect further gains by the single currency.
Furthermore, the Euro is notably undervalued on a long-term basis and should be trading higher thanks to Germany’s impressive export engine.
However, the European Central Bank’s policy of printing money and keeping interest rates at record-lows have seriously undermined the currency for years now.
The ECB is now looking to end these Euro-negative policies and the currency has responded accordingly.
The currency could finally be embarking on a journey back to fair-value and this could see it trample on all contenders over coming days, weeks and months.
The Euro will be Allowed to Run Higher
This week we have seen the Euro record fresh multi-year highs against most majors following the release of a speech by the Executive Board member Benoit Coeure on the international impact from the ECB’s QE programme.
“From an FX point of view, key for the markets seemed to be the statement that the EUR weakness that accompanied the launch of the programme was not a policy objective in itself,” says Valentin Marinov, Head of G10 FX Strategy at Credit Agricole.
Is this a signal that the ECB is okay with the Euro rising as it has?
After all, in the past there have been suspicions that the ECB has actively sought to ensure the Euro stays at competitive levels as it keep inflation elevated and aids the export of European-manufactured goods, just think of German cars.
“We also think that the markets responded the way they did because the speech made no mention of the latest EUR-appreciation and was therefore seen as a tacit endorsement of the price action in the FX markets,” says Marinov in a briefing to clients dated July 12.
So, does the ECB care about the EUR?
“We still think that the answer is yes, even though we have to admit that we were expecting the Governing Council members to be more proactive in voicing their discomfort about the extent of the recent EUR-appreciation already,” says Marinov.
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Credit Agricole still believe that any sustained currency gains from here could pose a clear downside risk to the Eurozone inflation outlook in the next 6M-12M especially given the worsening outlook for oil.
So those watching the Euro and betting on further gains must be wary of this.
The ECB might fight back and extend its quantitative easing programme if inflation rates fall dramatically, something that would certainly have a positive impact on the value of the single currency.
“In addition, further unwarranted FX appreciation will only add to the ongoing tightening in the Eurozone financial conditions on the back of the mini ‘taper tantrum’ in the EGB market,” says Marinov.
However, Credit Agricole are positive on the Euro’s trajectory from here and we see this as being suggestive that the Pound / Euro rate will continue to struggle for months to come.
The Pound has recently hit an eight-month low against the Euro and could well be on the way to test the 1.11 area in coming weeks.
“In all, EUR will continue to reign supreme in the absence of any evidence that the ECB is worrying about the impact of the FX appreciation on the economic outlook,” says Marinov.
Looking ahead, the July ECB meeting next week could provide the best venue to express any such concerns.
Further, it is suggested the ECB is not necessarily out of options when it comes to containing the currency rally in the near-term.
“Indeed, we suspect that any potential delay of the QE taper announcement could serve as a dovish surprise to the EUR-bulls,” says Marinov.
Credit Agricole are forecasting the EUR/GBP exchange rate to trade at 0.87 by the end of the year where the rate should stay at until the end of the forecast horizon in March 2018.
This equals a Pound to Euro exchange rate at 1.1494.