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Euro Outlook: Europe's Covid Surge Only Adds Downside Momentum says Morgan Stanley


Above: File image of Chancellor Angela Merkel © European Union.

Germany's coronavirus situation was on Wednesday described as "dramatic" by Chancellor Angela Merkel, raising expectations that further societal curbs to control the virus could be introduced.

Merkel's words came on the day Germany's Robert Koch Institute reported confirmed cases had increased by 52,826 as a new wave of infections gathers pace.

For the Euro, Germany and the wider Eurozone's rising cases pose headwinds according to analysts at investment bank Morgan Stanley who anticipate the currency's recent trend of weakness to extend.

"There has indeed been a notable drop in the 7d average of daily COVID cases in the US. At the same time, there has been a very strong pickup in COVID cases in Europe over the past few weeks, reaching levels last seen in April this year," says Matthew Hornbach, a global macro strategist at Morgan Stanley.

Eurozone covid crisis

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Merkel did not suggest any imminent change to restrictions, but Hendrik Wuest, the premier of North Rhine-Westphalia, who chairs the body that groups Germany's regional premiers, said on Tuesday he would be pressing for further measures.

Measures would include the demand of proof of vaccination or recent recovery from COVID-19 for all indoor leisure activities, and require vaccinated people to also present a negative test for risky environments, a regional leader said on Tuesday.

Further curbs would impact negatively on the economic recovery of the Eurozone's largest economy; and even without curbs consumer and business confidence is likely to fall back as people self-regulate contact in the face of rising cases.

An example of such behaviour was witnessed in the UK in July-August where economic activity all but stalled as cases rose even as restrictions were abandoned.

Hornbach says the prospect of additional lockdowns in the Eurozone may seem distant, but quickly rising Covid cases can cause disruptions to economic activity as workers need to self isolate, potentially causing problems with supply chains and labour supply.

The UK is meanwhile seeing cases churn at relatively high numbers and pandemic specialists are confident a new major surge is unlikely, meaning economy-sapping restrictions will be required over the winter.

This creates a divergence in economic trajectory that would favour the Pound relative to the Euro.

Euro in decline

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"A further acceleration in cases across Europe over the coming weeks would likely raise expectations for further underperformance of the Eurozone economy relative to the US and put downward pressure on EUR/USD," says Hornbach.

New Covid-19 restrictions were announced in the Republic of Ireland due to "another surge" of the virus, the taoiseach Micheál Martin said on Tuesday.

"Advice is now that everyone should work from home unless it is absolutely necessary," he said.

The Nertherlands has meanwhile announced a return to partial lockdown in the country in a bid to combat the spread of coronavirus while Austria has imposed a lockdown on unvaccinated citizens.

"The euro is sinking, stretching its week-long slide," says Raffi Boyadjian, Lead Investment Analyst at

"Worryingly, this comparative underperformance comes even before fresh restrictions have started to kick in across Europe to fight rising Covid infection levels. Austria and the Netherlands recently introduced new measures to contain the latest virus wave, while Germany is also considering tighter curbs," he added.

Mazen Issa, Senior FX Strategist at TD Securities, expects the ongoing decline in the Euro to extend.

"Next month's ECB meeting will be key, but until then, there is little in the way to stop EURUSD's drip lower and keep the broad USD on its front-foot," he says in a recent briefing.

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TD securities warned recently that the U.S. Dollar's tactical setup from seasonal, positioning and valuation had shifted more in its favour.

"With US CPI shattering consensus expectations this, we have the catalyst," says Issa. "We also note that the momentum indicators continue to suggest a drip lower for EURUSD. 1.1420 marks the next support marker but this does not look formidable. Below this, there isn't much in the way of support until 1.13," says Issa.

Added barriers to Eurozone economic activity come before the region has even been able to catch up with the U.S. which is now well above its pre-Covid size, giving little impetus to the European Central Bank to consider tightening its monetary policy settings.

"Europe is facing larger gaps in activity and inflation from pre-pandemic levels in comparison to the US. In terms of output, Europe is still 0.5% below its 4Q19 level, whereas the US economy is now 1.4% bigger than its pre-pandemic level," says Paul Meggyesi, a strategist at JP Morgan.

JP Morgan holds a "high-conviction medium-term bearish EUR/USD view".

They find the European Central Bank is in no position to end quantitative easing and then raise interest rates, a view that looks particularly valid given the deteriorating Covid situation.

JP Morgan holds a one-year forecast for EUR/USD of 1.12. However, the one-year ahead EUR/GBP exchange rate is around about current levels at 0.84, which gives a GBP/EUR point forecast of 1.19.

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