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- EUR/USD spot at time of writing: 1.0936
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The Euro-to-Dollar rate was lifted into the holiday weekend on Thursday by a broad downturn in the greenback and mounting hopes that Eurozone finance minister will put differences aside and agree on a mechanism for providing financial life support to members who've been hit hardest by the coronavirus.
Eurogroup president Mario Centeno said via his Twitter account late Thursday that Eurozone finance ministers are close to agreeing a response to the coronavirus crisis, hours after Dutch Prime Minister Mark Rutte was quoted saying a deal could be done ahead of the holiday weekend. Finance minister Bruno Le Maire was also reported to have told the French press the Eurogroup is making progress, although it remains to be seen if the bloc's purseholders will reach the unanimous decision that's required.
Optimism about a European contribution to weaker member states' bid to plug the hole torpedoed into their economies by coronavirus containment efforts gave a lift to a Euro-to-Dollar rate that was already climbing amid weakness in the greenback. Thursday's 0.80% increase brought the Euro back into the black for the week, with a gain of 0.92%, although sustaining the upward move once into the next holiday-shortened week could be difficult if a deal is not reached.
"The bulk of the burden of costs related to the pandemic will remain with the national governments and the standoff on common debt issuance and pooling of risk between the richer and poorer euro area countries is seemingly no closer to being resolved," says Marchel Alexandrovich, an economist at Jefferies. "Everything will depend on how high the costs from this recession will turn out to be and whether some countries will become overwhelmed by the economic emergency well after the worst of the health emergency passes."
It's not clear what shape the support package will take although leaders of Germany and the Netherlands both ruled out 'coronabonds' on Thursday, which would see mutualised debt supporting companies and households who're struggling amid the virus 'lockdown.' This could mean the finance ministers intend to call on the European Stability Mechanism (ESM), a bailout fund formed during the dark years of the debt crisis, which has a €500bn capacity to support member states who're in difficulty. The ESM is controversial because it imposes punitive conditions on those who use it.
National governments, including some who can ill afford it, have put funding worth double-digit percentages of GDP on the table after having placed their economies into 'lockdown' in the hope of slowing the spread of the coronavirus. Those measures have curtailed incomes across the board, likely driving historic contractions in GDP this quarter, and necessitated unprecedented fiscal actions. But a combination of currently-suspended EU fiscal rules and the lack of a meaningful financial contribution from the bloc itself has become a politcal as well as economic problem for Italy, Spain and France.
"The costs for the contributing countries ‘disadvantaged’ by common debt issuance are not much more than a rounding error," Alexandrovich says. "So while there are certainly a number of reasons why common debt issuance remains a sensitive topic for the euro area, the costs involved with such a move are clearly not what is holding some countries back from giving their support."
Weighed down by already heavy debt burdens and weary from years of austerity, some Eurozone governments have called for joint underwriting of crisis-fighting bonds that would presumably trade on the market like a sovereign debt. Those countries might struggle to raise money from the financial markets if it wasn't for the European Central Bank (ECB), which has expanded its quantitative easing programme by €850bn since the start of the crisis and tilted purchases heavily toward Italy and Spain.
The UK government may have had similar trouble to the 'periphery' of late, given that it asked the Bank of England (BoE) on Thursday to top up its 'overdraft' so that it doesn't have to rely so heavily on the markets in the short-term. This is after announcing new spending that could push the budget deficit above 10% of GDP this year while adding that as well as an additional 15% to the national debt if public guarantees of business interuption loans to firms are triggered.
"The fundamental problem here is not that the Eurogroup couldn’t agree to the terms of what is essentially a bailout this week. The fundamental problem is that they are talking about another bailout. The only reason that the EUR and Italian debt are not collapsing as a result of this is that the ECB has already committed itself to buying a larger amount of bonds on the secondary markets, under the existing capital key. So we don’t have an acute situation which is boiling over," says Stepehen Gallo, European head of FX strategy at BMO Capital Markets.
The ECB left its "capital key" unchanged when increasing the size of its bond buying program but decided to be "flexible" in how it interprets its obligation to abide by the key, which weights purcashes largely according to a member state's size. This has enabled the ECB to buy mostly 'periphery' country debt in its latest round of purchases, accounts from the bank revealed this week, although the absence of a change to the key means the bank will inevitably have to underweight those countries sooner or later.
Secondary market purchases have kept bond yields low and will have obscured outflows from, as well as any buyers' strike on, certain countries' debts. Outflows combined with a buyers' strike was what undermined the Euro during the debt crisis so without the ECB there's no telling where some bonds and the Euro itself will have ended the week.
"A near decade of austerity, resentment and the hollowing out of the center ground in European politics have further stigmatized the notion of bailouts to the point where nobody really wants them. At all. Basically, many governments fear the ultimate political backlashes that these mechanisms produce, and with good reason," Gallo says. "While any forthcoming agreement will be a "market positive" in the short-run, all the past evidence has shown that these agreements tend to exacerbate crises when various factors pile up over the medium-run. In fact, one of the best examples of this is the Eurozone itself."
Central and North European concerns about a profligate 'periphery' have stymied debt mutualisation throughout the life of the Euro - a mutualised currency that's cost some nations dearly while rewarding others immensely - and have done so again this week. But the debt-laden and austerity ridden countries have suffered the most severe outbreaks of coronavirus in the Eurozone, leading to significant economic costs that could easily become political further down the line.
It's the politics of the above lopsided trade off that are rearing their heads again after years of Euro-induced austerity and as the crippling financial cost of coronavirus containment measures mount. This could prompt a conversation in some countries further down the line, while heading into the 2022 election cycle, about whether the Euro was really such a good idea after all.
"It’s alarming when some press reports circulate soundbites from EU leaders which demonstrate their supposed commitment to the bloc. The problem is not their lack of enthusiasm for the project," Gallo says. "The problem is that they all have different and competing ideas of how they want the project to serve their own interests. So when press reports suggest that the struggle to reach a deal is simply down to two holdout countries, the underlying reality is a lot more fundamental, and rather intractable."
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