© European Central Bank
- EUR faces a long, winding road to recovery say multiple analysts.
- ECB to bring out punch bowl again as inflation outlook deteriorates.
- Inflation is waning at time when risks to Eurozone economy are rising.
- Analysts warn on ECB outlook as Draghi prepares 2019 Sintra address.
The Euro faces a long road to recovery against the Dollar even as the outlook for the U.S. currency grows darker by the day, according to multiple analysts, many of whom are warning clients that the European Central Bank (ECB) could soon bring out the proverbial punch bowl again.
Europe's single currency has been under the cosh in 2019 due to a weak continental economy, which is being threatened further still by the latest escalation in the U.S.-China trade war. But the Sino-American dispute is not the only threat to the Euro because there's also a litany of home grown risks looming over the currency.
Now, and with financial markets already staring down the barrel of a further increase in hostility between the U.S. and China, the Euro is heading into a second-half that will also see it have to contend with the business end of the Brexit process as well as fresh angst between the Italian government and European Commission.
This has got analysts warning that fresh interest rate cuts or another bond buying programme could be in the pipeline, which would risk condemning the single currency to an even longer period of weakness because lower interest rates would drive capital out of, and deter it away from, the Eurozone.
"Beset by weak growth, held down by negative short- and long-term interest rates and a central bank that is likely to be forced into further easing of one kind or another, the euro still lacks home-grown support," says Kit Juckes, chief FX strategist at Societe Generale. "Absent home-grown support, a euro bounce is dependent on weakness elsewhere. The dollar is now very overvalued, and as growth slows and the Fed embarks on an easing cycle, that is likely to be the main source of euro strength."
Above: EUR/USD rate shown at hourly intervals, alongside the Dollar Index (orange line, left axis.
Presidents Donald Trump and Xi Jingping are expected to meet on the sidelines of the latest G20 summit in Osaka, Japan at the end of the month although analysts see the meeting, which is yet to actually be scheduled, as merely a prelude to another increase in U.S. tariffs.
The U.S. lifted in May, from 10% to 25%, the tariff levied on around $200 bn of imports from China. The remaining $300 bn of China's annual exports to the U.S. are expected to be hit by a 25% tariff after the G20 if Jingping doesn't agree to enter a deal that his negotiators only recently backed out of.
This, playing out against the backdrop of an October Brexit deadline and new clash between Italy and the European Commission over spending, could hurt the Eurozone economy. Eurozone growth halved from 0.4% to 0.2% in the third quarter of 2018, when the earliest U.S. tariffs were imposed on Chinese goods.
Threats to the continental economy are mounting at a time when market expectations of inflation in five years time are in freefall, which is not good for the ECB or Euro because price pressures would be further undermined by another growth slowdown and the ECB needs to lift inflation to the target of "close to but below 2%".
"Inflation expectations in the euro zone are in free fall," says Ulrich Leuchtmann, head of FX strategy at Commerzbank. "The ECB – according to the EU treaty a central bank bound to pursue an inflation target – will not simply look on. I have to admit that I was initially sceptical when our ECB experts forecast a rate cut already for 2019. Recent developments have convinced me otherwise."
About: EUR/USD rate shown at daily intervals, alongside the Dollar Index (orange line, left axis).
Mario Draghi, President of the ECB, will open its annual conference in the Portuguese city of Sintra at 18:00 London time Monday by giving a short speech that's due to be followed by another address at 09:00 Tuesday. Draghi could use these to tip markets off about stimulus coming in the months ahead.
All speeches by central bankers are important for markets but this week's will be doubly so because the Sintra conference was the site of Draghi's June 2017 hint that the bank would soon begin winding down its quantitative easing (QE) programme. That 2017 address took the market by surprise and ignited a significant rally that dragged the single currency almost 10% higher against the Dollar by the time the curtain closed on 2017.
QE saw the ECB buy European bonds en masse to incentivise borrowing by forcing down bond yields, which are market interst rates, between January 2015 and December 2018. The idea was that this would lift inflation toward the target of "close to but below 2%" by stimulating faster economic growth, although it's debatable whether the policy ever worked at all.
Core inflation, which ignores movements in volatile energy items because of their distorting impact on organic price pressures, was just 0.8% in June 2019 and only 20 basis points above the 0.6% rate that prevailed in January 2015. This and the fact that markets currently anticipate little inflation at all over the next five years is why so many analysts now say the European Central Bank will soon get the proverbial QE punch bowl ut again.
"Market-based measures of inflation expectations are collapsing across the board (EUR 5Y5Y inflation swap now a mere 1.13%) and arguably the ECB, rather than the Fed, has a more compelling case for early easing. It is with this back-drop that ECB President Draghi opens the ECB’s Sintra forum tonight," warns Chris Turner at ING Group. "There are enough EUR negatives out there to prevent EUR/USD breaking out of a 1.10-1.15 range this year."
Above: EUR/USD rate shown at hourly intervals, alongside the Dollar Index (orange line, left axis).
Societe Generale, Commerzbank and ING all forecast a higher Euro-to-Dollar rate in time for year-end 2019 but the scale of gains projected is paltry when compared with rally ignited at Sintra in 2017, particularly when considering the driving factor behind the increase.
The Federal Reserve is expected to cut its interest rate twice this year, signalling the end of a three-year cycle of rising rates that had previously supported a steady advance by the U.S. greenback against many of its rivals.
However, the Dollar decline that's expected to result from those rate cuts is the only source of upside envisioned for the Euro over the six months or more, because the Eurozone economic performance is seen remaining lacklustre.
Societe Generale's Juckes forecasts the Euro-to-Dollar rate will finish 2019 at 1.16 while ING's Turner has penciled in a 2019 finish at 1.15. Commerzbank's Leuchtmann also projects the exchange rate will end the year at 1.16.
All are downgrades from January projections that had suggested the Euro could rise above 1.20 this year.
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