The Euro-to-Dollar Rate Decline Has Further to Go says BMO, as EU Parliament Elections Loom

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- EUR to hit fresh lows as toxic cocktail of risk weighs says BMO.

- Trade war, Brexit and EU elections may hurt EUR in first half.

- But global economic recovery could lift EUR later in the year.

The Euro-to-Dollar rate has further to fall, according to the latest forecasts from BMO Capital Markets, as a multitude of economic and political factors will conspire to push the single currency lower during the months ahead. 

Markets are hoping the March month will bring an end to the tariff fight between the U.S. and China, which would provide a welcome boost to the ailing Eurozone economy, but the idea of a tariff rollback happening over the coming weeks is pie in the sky according to the Canadian investment bank. 

"Our 1-3M profile factors in a dovish March ECB rate decision, an above-consensus probability of a “no deal” Brexit and no rollback in US/China trade tariffs," says Stephen Gallo, European head of FX strategy at BMO.  

BMO is assuming that tariffs on Chinese exports to the U.S. will remain in place beyond the March 01 deadline for a deal that ends the trade war to be done, although the bank hasn't said whether this is becauase an extension of the talks is likely, or an outright failure. 

President Donald Trump told reporters Thursday he is not planning to meet Chinese President Xi Jingping before March 01, which is the date when tariffs on Chinese exports more than double to 25% if a deal addressing Beijing's "unfair trade practices" isn't done.

Some have since speculated that Trump could defer the tariff increase for another 90 days, but this wouldn't cut the Eurozone much slack because the existing 10% tariff on $250 bn of annual goods exports is already hurting China. 

"There is no US-China trade deal that can be done: those tariffs are going up from 10% to 25%," says Jane Foley, a strategist at Rabobank. "25% tariffs would be ugly as a more detailed trade breakdown already shows that where they are at that level both import volumes and values are plummeting, while firms are shifting production outside China (i.e., the tariffs are working)."

Chinese growth has slowed in recent quarters despite efforts by policymakers to support the economy. Most analysts say it will slow much further in 2019, even without an increase in U.S. tariff rates.

Optimism and output among German and other European manufacturing companies have fallen in recent months as headwinds for China's economy have mounted. But EU rules that have reduced output from the automotive sector and civil unrest in France have also slowed the Eurozone economy.

Eurozone growth fell to 0.2% in the third and final quarters of 2018, down from 0.4% previously and 0.7% at the end of 2017. Annual growth was just 1.8%, down from 2.3% in 2017 and the European Commission said Thursday that growth of only 1.3% is likely this year.

Above: Euro-to-Dollar rate shown at daily intervals.

"We expect the EUR to contain a risk discount through the EU parliamentary elections in May," Gallo writes, in a note to clients Friday. 

Trade concerns are coming back and the Eurozone growth outlook is deteriorating just as the continent gears up for the latest EU parliamentary elections, which are expected to propel anti-establishment and anti-EU forces into the parliament in even greater numbers than before. 

Rome's high-profile showdown with the European Commission over the former's 2019 budget plans has driven increased numbers of Italians into the arms of anti-establishment and borderline anti-EU parties such as League and the Five Star Movement. 

Migration is a hot-button issue in Europe too, following the calamitous 2014 and 2015 attempts by Brussels and Berlin to prevent drownings in the Meditteranean, which brought a large influx of migrants into Europe.

That ultimately saw Brussels attempting to wrestle competence over aspects of external migration from member states, drawing the ire of some countries, but particularly the so-called Visegrad Four, who're also expected to send a potentially troublesome delegation. 

"The Eurozone is one of the biggest risks to the global economy, and the May EU elections could make governance of the bloc more difficult," Gallo says. 

Above: Euro-to-Dollar rate shown at weekly intervals.

Analysts fear that Eurosceptic delegations sent to the EU parliament by Italy and other member nations will be so large that they may end up having the clout to block the EU's political and fiscal integration agenda, which many say is key to ensuring the survival of the single currency.

Gallo makes no forecast for the outcome of May's vote, although French President Emmanuel Macron has repeatedly called for citizens in favour of political integration to vote for pro-EU parties in the parliament elections.

And in a similar manner, Italian and East European political leaders have called for citizens to support parties that want either radical reform of the EU and its rules. Some suspect those parties might want the project abandoned altogether.

France recalled its envoy from Rome this week after Italy's Deputy Prime Minister Luigi Di Maio met with leaders of the French Yellow Vests protests in Paris, where he was quoted saying; "A new Europe is being born of the 'yellow vests', of movements, of direct democracy."

Gallo says uncertainty about the outcome of the May election, the threat of a "no deal Brexit" playing out as well as the weak Chinese and Eurozone economies will be enough to ensure the Euro falls to new lows during the months ahead. 

He forecasts the single currency will decline to 1.11 before the end of April, but projects it will recover tio 1.16 by year-end if the worst of the above scenarios are avoided and the global economy picks up in the interim.


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