Euro Hit by Eurozone Bond Fears, Macron Rumours

Above: Emmanuel MACRON, President of France. Copyright: European Union.

The Euro looks to have been shaken by fresh nerves on Tuesday, with Eurozone bonds falling and talk of a potential resignation by the French president.

The Pound to Euro exchange rate is powering higher amidst increasing investor nervousness regarding the Eurozone outlook. The spread between the bond yields of France and Germany is at its widest since 2020, in a classic sign investors are nervous.

Other Eurozone countries are seeing their bond yields attract increasing premiums in an apparent sign the weekend's Eurozone election results are hitting the confidence that glues the Eurozone financial system together.

To be sure, we are not in a crisis, but it does suggest peak-Euro optimism might be waning.

Confidence took a hit after Europe 1 radio reported that France's President Emmanuel Macron had been discussing the possibility of resigning in case he obtained poor results in upcoming snap elections. However, it is reported that people close to the President denied this was the case.

The headlines are just the latest in a series of developments that point to increased political uncertainty in the Eurozone, which is weighing on Euro exchange rates and bond markets.

Pound Sterling gapped higher against the Euro on Monday following Eurozone elections that prompted French President Emmanuel Macron to call an election and saw Germany's ruling coalition suffer a drubbing. Gains have been sustained after the ONS reported wages in the UK rose 6.0% in April, which is far too high for the Bank of England as it tries to bring inflation back down to 2.0%.

To be sure, the UK unemployment rate has also risen and suggests an ongoing cooling in the labour market, but the Bank of England will have to proceed with caution when it comes to cutting interest rates. A slow and cautious rate cutting cycle is consistent with ongoing support for the Pound.

The more significant driver of the Pound-Euro equation at present is undoubtedly the Euro, where a noticeable political risk premium is emerging and has helped push Pound-Euro to 34-month highs at 1.1863, taking payments with competitive providers above 1.18.

Above: GBP/EUR at daily intervals. Track GBP/EUR with your own custom rate alerts. Set Up Here

"The euro remains on the backfoot following Sunday’s European election results," says Achilleas Georgolopoulos, Investment Analyst at XM.com. "The snap parliamentary elections called in France have been generating the most headlines, but the key event of the weekend was the very weak result achieved by the three coalition parties in Germany."

The analyst explains there are notable implications for Germany from these elections: from earning around 51% of the votes in the 2021 federal elections, the coalition crashed to just 31% support, raising questions about the viability of the existing government.

"Germany is almost considered the “sick man” of the eurozone with the end-2023 court decision also limiting the government’s fiscal room for 2024. New federal elections are out of the picture, but a weakened German Chancellor could have severe repercussions," says Georgolopoulos.

Rising Eurozone political uncertainty contrasts with the UK's relatively mundane political backdrop, where investors are well prepared for a significant victory by the Labour Party on July 04.

Labour is actually relatively closely aligned with the current Conservative administration in terms of economic policy, suggesting continuity for businesses.

"Markets don’t have much to go on regarding Labour’s economic policies but are likely to take the view that a change from the policy chaos of recent years is welcome. The UK equity market could benefit," says Chris Iggo, Chair of the AXA IM Investment Institute. "Equities are cheap, sterling is cheap."

A Bloomberg survey of investors found that more than half of 268 respondents said a Labour win would be best for the British Pound.

So we have a contrasting pro-GBP political setup contrasting with a more uncertain outlook for the Eurozone, and this is reflected in a rising Pound to Euro exchange rate.

"Regional politics in Europe are currently loaded with challenges. The expected boost in the standing of far-right groups in the European parliamentary elections reflects the broadening of support for issues such as nationalism and cultural identity which may have implications for matters such as EU enlargement, common European initiatives (such as climate change) and policies related to Ukraine," says Jane Foley, Senior FX Strategist at Rabobank.

Rabobank looks for weaker Euro exchange rates from here, maintaining a one-month forecast of EUR/USD at 1.07, with losses also being expected against the Pound and Krona.