Euro hits fresh seven-week lows as German political uncertainty offsets risk-on mood
- EUR/USD extends losses and hits fresh seven-week lows at 1.1450.
- Concerns about the German government's stability are weighing heavily on the Euro this week.
- French government debt has reached its highest level since 1978, adding pressure on the Euro.
The Euro (EUR) is failing to draw any support from the moderate risk appetite triggered by the recent pullback in Oil prices and extends losses against the US Dollar (USD) on Tuesday, hitting fresh seven-week lows below 1.1450. The growing political uncertainty in Germany, after the defeat of Chancellor Friedrich Merz’s CDU in last weekend’s state elections, has posed a fresh source of weakness for the common currency this week.
Merz vowed to remain in power until the economic reforms planned by his cabinet have been implemented, but the severe defeat in the Mecklenburg-Vorpommern elections, where the CDU failed to reach the 5% necessary to enter the parliament for the first time in postwar Germany has raised serious questions about his support.
But beyond that, Merz's weakness undermines confidence in the fate of the Eurozone’s EUR 2 trillion budget proposal that includes a significant boost to the bloc's defence program, especially if the pro-Kremlin Allianz fur Deutschland (AfD) increases its power in the national parliament. A report by the Financial Times citing German officials involved in the talks affirms that this weekend’s elections have forced the EU to reassess what it could achieve in the coming months.
Concerns about France's debt add pressure on the Euro
Beyond that, a minor rating agency has downgraded France’s government debt, which has reached its highest level since 1978, amid bond market turmoil. This has raised the alarm about more relevant downgrades, as the chances of any significant fiscal tightening being implemented are remote, which is adding pressure on the Euro.
In the calendar on Tuesday, the main event will be European Central Bank (ECB) president Christine Lagarde’s speech at a conference organised by the Ukrainian and Polish central banks. due later in the day. The ECB hiked its benchmark interest rate for the second time this year and hinted at further tightening ahead if inflationary pressures remain high. Lagarde is expected to stick to that message on her public appearances.
The US Dollar, on the other hand, is "deriving support from the sharp ongoing adjustment higher in US yields," according to analysts at MUFG/BTMU who observe that "the 2-year US Treasury bond yield has already increased by around 55bps since late last month as market participants have moved to price in a more extended Fed rate hike cycle." In their view, "the US rate market is expecting the Fed to deliver three more hikes in the year ahead," a profile that has been "supported by hawkish comments yesterday from regional Fed presidents, although neither is a voting member this year."
Euro FAQs
The Euro is the currency for the 20 European Union countries that belong to the Eurozone. It is the second most heavily traded currency in the world behind the US Dollar. In 2022, it accounted for 31% of all foreign exchange transactions, with an average daily turnover of over $2.2 trillion a day. EUR/USD is the most heavily traded currency pair in the world, accounting for an estimated 30% off all transactions, followed by EUR/JPY (4%), EUR/GBP (3%) and EUR/AUD (2%).
The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank for the Eurozone. The ECB sets interest rates and manages monetary policy. The ECB’s primary mandate is to maintain price stability, which means either controlling inflation or stimulating growth. Its primary tool is the raising or lowering of interest rates. Relatively high interest rates – or the expectation of higher rates – will usually benefit the Euro and vice versa. The ECB Governing Council makes monetary policy decisions at meetings held eight times a year. Decisions are made by heads of the Eurozone national banks and six permanent members, including the President of the ECB, Christine Lagarde.
Eurozone inflation data, measured by the Harmonized Index of Consumer Prices (HICP), is an important econometric for the Euro. If inflation rises more than expected, especially if above the ECB’s 2% target, it obliges the ECB to raise interest rates to bring it back under control. Relatively high interest rates compared to its counterparts will usually benefit the Euro, as it makes the region more attractive as a place for global investors to park their money.
Data releases gauge the health of the economy and can impact on the Euro. Indicators such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can all influence the direction of the single currency. A strong economy is good for the Euro. Not only does it attract more foreign investment but it may encourage the ECB to put up interest rates, which will directly strengthen the Euro. Otherwise, if economic data is weak, the Euro is likely to fall. Economic data for the four largest economies in the euro area (Germany, France, Italy and Spain) are especially significant, as they account for 75% of the Eurozone’s economy.
Another significant data release for the Euro is the Trade Balance. This indicator measures the difference between what a country earns from its exports and what it spends on imports over a given period. If a country produces highly sought after exports then its currency will gain in value purely from the extra demand created from foreign buyers seeking to purchase these goods. Therefore, a positive net Trade Balance strengthens a currency and vice versa for a negative balance.
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