German Elections: Euro's Weakness to be Short-Lived

The German federal election result has put the Euro under pressure, but we find many analysts and traders are confident the currency will bounce back.

The Euro fell sharply at the start of the week commencing September 25 as markets absorb German Chancellor Angela Merkel's diminished authority. 

The German electorate granted Merkel a fourth term as Chancellor but she must form a government with a coalition of junior parties.

Most analysts believe this will transpire, but it might be two months before Germany has a working government in place, posing the potential for extended uncertainty that might undermine the Euro.

“Uncertainties are Bund-friendly, peripheral bonds unfriendly, neutral for equities and negative for the Euro,” says Christian Gattiker, Chief Strategist and Head of Research at Julius Baer.

Indeed, many analysts have noted markets were becoming complacent to Eurozone political risks.

"Since the French elections, we’ve noted that the EUR may have been playing the role of a ‘political haven’ – especially when taking stock of the political risks plaguing the likes of other G4 currencies (namely USD and GBP). However, the return of the ‘populist voter’ in a European election is a reminder that political risks haven't completely abated for the Euro," says Viraj Patel, an analyst with ING Bank N.V.

Following the result the Pound-to-Euro exchange rate has rallied sharply to reach a new high of 1.1416 on Tuesday, September 26.

The Euro-to-Dollar exchange rate has meanwhile fallen back to 1.1827.

At the start of the week, the Euro was the day's second-worst performing major currency, after the New Zealand Dollar which is also subject to similar political uncertainties.

The Case for Further Euro Strength

However, for now, most analysts are broadly optimistic on the single-currency’s outlook.

“We agree that election developments do not represent a significant hurdle to further Euro gains going forward, although they are likely to subject the currency to some headline risk,”  says Chiara Silvestre, Economist at UniCredit Bank in Milan.

The view is shared at another major global financial institution who says that what really matters for the Euro is the improving Eurozone economy.

“In our view, most of the EUR’s gains are due to the sharp improvement in the Euro area economy in the last 18 months and the German election will do little to endanger that. Hence, we do not expect significant EUR downside to result from the election.” - Marvin Barth at Barclays.

Indeed, others point out that markets should not lose sight of the one important outcome of the election - Merkel is still in charge.

“While the Euro has seen some early weakness given the unexpected surge in support for the anti-immigration AfD party, it is likely that any weakness will be fleeting as Merkel takes on her fourth term," says Joshua Mahony, Market Analyst at IG.

Strategy-wise, the Euro's decline might be seen as an opportunity to profit on the next move higher.

“So the overall move has been fairly orderly. So is this just a minor bump in the EUR rally and an opportunity to buy?” notes the UBS spot desk in a briefing to clients at the start of the new week.

Peter Rosenstreich at Swissquote Bank is more confident in his stance on the Euro and  sees little of concern in the election outcome:

“For the first time in a long while, European politics is likely to drive the Euro higher. The incoming German government, to be led once again by Chancellor Angela Merkel, is clearly pro-European, even though the right-wing AfD party and the left-wing Linke party captured significant parliamentary seats in yesterday’s national elections.

“In the near-term, we are bullish on the Euro.”

However, politics is a factor in the Euro conversation once more and Kathleen Brooks at City Index points out that there are potentially bigger politically-orientated risks on the horizon.

“Even if we see a Merkel-inspired dip in the single currency, we still expect it to be relatively muted, with a move back to $1.1650 – the mid-August low- a potential possibility to the downside. However, the bigger risk to the euro is unlikely to come from Germany, but instead could come from Spain where the Catalan region is planning to hold an illegal referendum on independence on 1st October," says Brooks.

Beyond Catalonia, Manuel Oliveri, FX Strategist at Crédit Agricole CIB is looking to Italian elections in early 2018:

“We believe this weekend’s outcome is unlikely to trigger downside risks for the EUR. If anything, we expect the single currency to remain predominantly driven by central-bank monetary policy expectations, which should continue to put a floor under the EUR. In terms of political event risk, next year’s Italian election should warrant greater attention.”

So while most are willing to not give up on the Euro yet, we are seeing nerves appear with regards to political risks once more.

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