Euro could fall as debt crisis fears to dilute ECB rate hikes
The euro has steadily depreciated against a basket of major currencies since December. 2020. Tellingly, this turning point coincided with rising gold prices and the start of a rise in Fed rate hike expectations. The US central bank had signaled that it was done adding to Covid-inspired stimulus.
Unsurprisingly, the apparent start of the Fed’s tightening effort in June 2021 marked the beginning of the deepest dip in this bearish trajectory. Markets believed that the ultra-dovish ECB would not be as quick to follow the US lead as many other main central banks, to push interest rate differentials against the euro.
Euro downtrend halts as ECB rate hike bets rise (weekly chart)
Source: Trading View
Then, in the second quarter of 2022, European officials finally signaled that they were ready to act as regional CPI inflation hit record highs. It would reach a stunning 8.1% in May. The Euro bottomed out and began to edge higher as rate hike expectations began to be absorbed by prices.
Euro debt crisis fears return as ECB prepares to battle record inflation
The speculation peaked on June 9, when the ECB officially announced further interest rate hikes. The central bank previously said it would end bond purchases – a non-standard form of stimulus – in July. Less than a week later, an emergency meeting was called and a mandate given create a new tool against “fragmentation.’
This stopped the euro’s ascent in its tracks. Expectations of ECB tightening have revived concerns about high debt levels in some eurozone economies. The spread between Italian and German benchmark 10-year government bond yields widened sharply to a two-year high of 242 basis points (bps) after the June policy meeting.
Manage “fragmentation” – i.e. divergent lending rates on the other side Eurozone states – it now looks like this will necessarily keep ECB tightening modest relative to its global peers. This puts the single currency at a significant disadvantage, suggesting that the downtrend should resume.
Fiscal reform could unleash the ECB, but it probably won’t be soon
The kind of structural reforms needed to untie the hands of the ECB – creating a common “eurobond” or finally reducing debt levels in southern Europe – seems distant at best, if only because the Franco-German critical thrust necessary for progress is significant. Berlin and Paris should focus on other priorities.
The war in Ukraine and its implications for regional geopolitical and economic stability – most pressing, the challenge it poses to securing energy supplies at a reasonable cost without relying on Russia – are clearly in mind. Disruption of trade with a key Another concern is the market in China amid that country’s Covid-related shutdowns.
A paralyzed administration in the eurozone’s second-largest economy further complicates fiscal matters. French President Emanuel Macron managed to win another term, but his coalition lost its majority in the legislature. It means that the fragile government will struggle to do anything big in the next five years.