Euro Tipped to Take a Hit Next Week if Merkel Coalition Fails, EU Summit's FX Focus Shifts Away from Pound Sterling and Brexit

Above: The UK's May and Germany's Merkel at a previous EU summit. They meet again on Thursday and Friday. Image © European Council

A flash comment from an analyst on the Thomson Reuters currency desk casts light on the risks facing the Euro next week.

"The Euro will take a hit if German Chancellor Merkel's CDU-CSU/SPD coalition government collapses next week, with the outcome of the two-day EU summit which gets underway in Brussels Thursday key to gauging that risk," says Robert Howard, an analyst on Thomson Reuter's currency desk in London.

This is an interesting point - previously the summit was all about Brexit, and therefore markets were looking to any potential impact on the British Pound posed by the summit which starts on Thursday, June 28.

However, the ongoing Euro-wide tensions concerning migration - particularly with regards to German political stability - appears to be shifting the risk factor onto the Euro.

Pressure on Merkel remains a feature of German politics ahead of the EU summit - which runs through to Friday, June 29 - with Bavaria's CSU party insisting that they want to unilaterally re-impose border controls from next week in contravention of EU rules.

The CSU are long-standing allies of Merkel's CDU, and a key component in the ruling coalition; without them the coalition fails and Merkel could well be starting a job hunt.

Right now markets are hoping Merkel will muster her now-infamous political skills to push through a deal with other EU countries that will see them hold onto asylum seekers who register in their country.

For the CSU, the continued acceptance of asylum seekers from elsewhere in the EU forms a danger point for their hold on Bavarian power, as the AfD party is seen stronger on the issue.

"Investors may take fright if the political situation in the largest euro zone nation takes an uncertain turn weeks after the formation of a populist government in Italy, the third largest euro zone nation. The alliance between the CDU and CSU stretches back 70 years, so its breakup would be a major event. A Bavarian regional election will be held in October, with a recent poll suggesting the CSU is on course for its worst-ever result," says Howard.

Based on the above risk dynamics, we would expect the Pound-to-Euro exchange rate to find support and the door to a move back towards the centre of the multi-month range remains a high-probability outcome. We would see 1.14 being triggered ahead of a move to resistance at 1.15 in the event of sustained Sterling strength. 

A move beyond 1.15 remains a hard ask until such a time as the future relationship between the EU and UK becomes clear.

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