Euro Exchange Rate Robust, But Risks Start to Simmer

"The euro has been remarkably robust amidst the current turbulence, although the EMU spread universe has also begun to simmer." - Ralf Umlauf, Helaba Bank.

The euro is on the move higher having broken fresh ground against both the US dollar and British pound of late.

The single currency is undoubtedly a beneficiary when markets sell-off, as they are doing at present, but this is simply a result of the currency having been a funding currency over the course of many years.

Investors are simply buying the euro to settle borrowing obligations made in earlier times to fund higher-risk and higher-yield investments.

This goes some way to explain the euro to dollar exchange rate's surprising recovery in the last two months; we have seen it rise from historic lows of 1.05 to 1.12, despite at times wildly diverging central bank policy agendas.

But, one feels that the shared currency could now be getting ahead of itself. In short, this is no safe-haven currency.

"The euro has been remarkably robust amidst the current turbulence, although the EMU spread universe has also begun to simmer. Sharply rising risk premiums in Greece (general strike, sell-off on the Athens stock market) and Portugal (concerns about reform policy) are not currently weighing on euro sentiment," says Ralf Umlauf, analysts at Helaba Bank in Frankfurt.

Latest Pound/Euro Exchange Rates

	Live: 1.1391▼ -0.13% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.1004 - 1.1049
**Independent Specialist	1.1232 - 1.1277 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

AFEX, the foreign exchange brokerage, have told clients they are nervous about the longevity of the current euro-favourable risk-off environment:

"Since these risk-off periods also tend to prove relatively short-lived it will also be necessary to see EUR/USD buying interest continue once volatility elsewhere subsides before any longer term reversal of fortune argument gains credibility.”

Yet on the other hand, they do not see where future downside could come from either:

“Even if another new cyclical low is scored for this pair over coming months preliminary evidence suggests any such sell-off toward parity is itself likely to be relatively short-lived.”

Nevertheless, the bottom line remains that much of the single currency’s robustness appears to come from safety flows, which are now a major factor in its valuation.

The ECB's March Meeting Will be Key

Whilst analysts had earmarked March as a time when the Fed was most likely to raise interest rates again, this now seems unlikely; however, the probability that the ECB will cut their rates in March is now almost taken for granted.

Mario Draghi commented at the January press conference that the ECB would be “reviewing” and “reconsidering” it policies at the March meeting, and since then several analysts have attempted to forecast what the ECB might actually decide to do. 

Currently, both BoFa and Barclays expect the ECB to cut deposit rates by -10bps to -0.4%.

In a recent note, for example, Barclays said:

“We expect the ECB to fight a worse-than-expected inflation outlook with additional monetary easing: a 10bp depo rate cut in March followed by another later in the year, possibly as early as June, which would bring the depo rate to -50bp.”

This echo’s BoFa’s outlook, which also calls for a 10 basis point cut.

In addition, both banks see the policy change as inadequate and likely to be followed up with changes to the QE programme at latter meetings, with BoFa expecting a possible extension of ECB purchasing programme into commercial paper and Barclays expecting the ECB to widen into hybrid part-government owned part private organisation debt.

Barclay’s also point out that the ECB will likely only reduce the deposit rate to a minimum of -0.50%, because below that, it could become a hampering risk factor in itself:

“Even if we believed that further depo rate cuts were an option (ie. below -50bp), we see limited space for such moves.

“Deeply negative rates in a context of rising liquidity surplus can severely hurt banks’ profitability, thus raising the risk of an increase in bank lending rates.

“Not only do banks have to deal with low yields and compressed margins that affect their earnings on bond portfolios and lending activity, but further, in some euro area countries, their ability to pass on the cost of ECB deposits to final clients is limited by national legislation that does not allow banks to charge negative rates on retail deposits.”

First estimate Q4 GDP data for the euro-zone out on Friday is probably the most important release for the currency this week, since a lower-than-expected result could weigh on the currency as it would make it almost dead certain the ECB would announce more accommodation in March.

The quarterly GDP growth rate has been falling steadily since peaking at 0.5% in Q1 of 2015 – in Q2 it fell to 0.4%, and in Q3 it came out at 0.3%; if the trend continues it could come out at 0.2% - any lower and a March move from the ECB would be a fait accompli.

Other Factors

Whilst global risk trends and monetary policy are two major factors impacting on the euro, some analysts nevertheless see longer-term fundamental sources of strength, for example, DNB Bank, which summarised outlook as follows:

“Long term, abating downside risks in the EMU (European Union) and Current Account surplus will support the EUR.”

By alluding to, ”abating downside risks” DNB may be highlighting the green-shoots recovery the region has made, with recent data proving there has been a rebound in key sectors such as housing, lending and employment.

DNB reiterate their point for EUR/USD: 

“Despite the anaemic recovery in the EMU, the risk of an unfavourable outcome will gradually be reduced- EMU current account surpluses and c’bank demand for EUR should result in a stronger EUR going forward.”

Technical Outlook Overall Still Bearish

From a technical point of view analysts still predominantly see the EUR/USD pair as in a long-term down-trend which is likely to continue.

Commerzbank’s Karen Jones, for example, remarks: “EUR/USD eased back on Friday and although it came close to it did not overcome the 1.1260/96 23.6% retracement of the move down from the 2014 peak and the 61.8% retracement of the move down from the August 2014 peak. 

“While the market continues to close below here we will maintain a negative bias – above will force us to neutralise. “

Technical analysis from Swissquote, broadly shares the view, although they see key resistance at much higher levels:

“In the longer term, the technical structure favours a bearish bias as long as resistance holds.

“Key resistance is located region at 1.1453 (range high) and 1.1640 (11/11/2005 low) is likely to cap any price appreciation.

“The current technical deteriorations favours a gradual decline towards the support at 1.0504 (21/03/2003 low).”

One bullish voice comes in the form of Hantec’s Perry, who says:

“I am still confident that the outlook for the euro has now changed on a medium term basis.

“The hourly chart shows overbought momentum having unwound and the pair beginning to settle.

“There is price support now at $1.1070 which the bulls would ideally hold on to.

“I now see corrections as a chance to buy and I will be looking for buy signals.

“Resistance is near term at $1.1165 and $1.1243.”