Euro Forecast Higher into Year-end, but EU Council Meeting to Discuss Rescue Fund is a Key Stumbling Block

- Euro has rallied over recent weeks
- Optimism over rescue fund a key ingredient to gains
- But EU leaders yet to agree on shape and substance of fund
- USD looking increasingly unattractive to some analysts

From left to right: Mr Charles MICHEL, President of the European Council; Ms Angela MERKEL, German Federal Chancellor; Ms Ursula VON DER LEYEN, President of the European Commission; Mr David SASSOLI, President of the European Parliament. Copyright: European Union

The Euro is being backed to advance against the U.S. Dollar through the second half of 2020 by a number of analysts citing the potential for Dollar underperformance in the second half of 2020 as a global economic recovery gains traction.

But others warn that the Euro's ability to advance further will be dependent on whether the EU passes its coronacrisis recovery fund at some point in the near future, with next week's meeting of EU leaders at the European Council being seen as a key event on the horizon.

EU leaders will meet to try and reach agreement on what the embryonic Next Generation EU rescue fund will actually look like once fully fledged, with most foreign exchange analysts expecting the ambitions of the fund to be watered down in the face of opposition from frugal EU nations, spearheaded by the Netherlands.

Sentiment towards the Euro has improved over recent weeks after the European Commission proposed their €750BN rescue fund which would offer loans and grants to EU countries and viable businesses to embed the region's recovery from the coronacrisis. The borrowing required to fund the loans and grants would be underwritten by all EU countries, which some have objected to.

Key to the Euro's outlook is how similar the final package resembles the current proposals, with further gains possible if only minor changes are adopted.

The plan's chances of success will likely be determined at a European Council meeting scheduled for July 17 and 18 where markets would like to see some substantial progress if the Euro is to hold any of its recent gains.

"Crucial for the EU and the euro is the July 17/18 summit, featuring discussions on the EU recovery fund. We see a high chance of progress, which would lift the Euro," says Thomas Flury, Strategist at UBS.

The Euro would likely benefit should the final package be as close as possible to the existing proposals and the summit will likely see the 'frugal four' of the Netherlands, Austria, Denmark, the Netherlands and Sweden pitted against Germany, France, Spain and Italy.

According to Valentin Marinov, Head of G10 Strategy at Crédit Agricole, the EU recovery fund would support the Eurozone, and by extension its currency, by fulfilling two objectives: (1) the delivery of meaningful fiscal stimulus; and (2) the removal of the tail risk of Eurozone break-up.

"This could encourage further (unhedged) portfolio inflows into the region’s stock markets in our view and boost the outlook for EUR/USD," says Marinov.

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One analyst says it is too optimistic to expect a breakthrough as early as next week, and patience is required as typical of EU decision making but ultimately a breakthrough will come.

"It seems likely that in the coming months under German EU Presidency a compromise will be reached for the EU recovery fund. In that case the “internal divisions” within the EU, which weigh on the euro, would no longer be an issue for the market," says Antje Praefcke, FX and EM Analyst at Commerzbank. "If we take a step back and consider the general situation in my view it makes sense to expect a certain stabilisation and strength for the euro over the coming months as we are assuming in our EUR-USD outlook."

Looking beyond domestic matters, UBS are backing the EUR/USD exchange rate to gain as the Dollar sees its strength fade in the second half of the year as a global economic recovery gains traction.

"We think the EUR/USD rally will continue as lockdown measures are eased and global growth rebounds. The creation of an EU recovery fund should support the EUR," says Flury.

UBS are expecting the Euro to rise against the Dollar in the second half of 2020 as economies recover from their covid-inspired troughs. "Lockdowns have been eased and the economic response to this should be visible in the data soon," says Flury.

"Given the still-high number of new infections it is difficult to estimate when the authorities will be able to reduce their easing measures. Another large fiscal package is expected around the end of the month. For once, Europe looks more stable than the US. Economic lockdowns have been eased with only a small rebound in COVID-19 infections so far," says Flury.

Commerzbank's Praefcke also picks up on the theme of the relative stability of the U.S. Dollar being questioned, just as the stability of the Euro looks to be improving.

"I may be wrong, but there is every possibility that as the year progresses, the euro will emerge as a haven of stability," says Praefcke. "The US on the other hand seems increasingly divided during the Presidential election campaign over the coming weeks and months while the incumbent President is likely to continue his verbal attacks on the foreign policy front in the hope of attracting votes."

The analyst adds that the economic effects of the covid pandemic are likely to be substantial, particularly given the case load in the country continues to increase. "It will yet remain to be seen who will emerge better from the crisis, the US or Europe. And in the end the US dollar’s rate advantage is only marginal now and therefore not a major argument in favour of the greenback these days," says Praefck.

Commerzbank forecast the EUR/USD exchange rate to end the year at 1.14 while EUR/GBP is predicted to trade at 0.88 (GBP/EUR at 1.1364)..

UBS forecast the upside for the EUR/USD exchange rate to remain limited around their forecast of 1.19 next year.

Crédit Agricole meanwhile forecast EUR/USD to be at 1.15 by the end of 2020, with the EUR/GBP exchange rate forecast at 0.89 (GBP/EUR at 1.1236).