Euro Gains Likely Unsustainable: Commerzbank

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Any gains by the Euro over coming sessions will likely prove unsustainable says German based lender and investment bank Commerzbank.

The call comes on the day it is confirmed gas is flowing through Nord Stream 1 and the European Central Bank raises interest rates.

"Gas is flowing again! But an acute energy crisis has by no means been averted. On the contrary — the EU yesterday called for a significant reduction in gas consumption of 15% over the next eight months and is threatening mandatory rationing," says Esther Reichelt, FX and EM Analyst at Commerzbank.

Whether or not Russia would reopen Nord Stream 1 following a scheduled ten day planned maintenance was cited by analysts as one of the key risks to Euro exchange rates this week.

Although the pipeline has restarted reports suggest flows will remain well below full capacity for the foreseeable future.

"The EU continues to steer almost blindly through the crisis. Neither can the success of savings measures be reliably estimated, nor is it known which gas supply it will be able to draw on at all. The Russian president has already announced a further reduction in the supply volume for next week, and a complete supply freeze cannot be ruled out," says Reichelt.

Commerzbank says the politics of gas supply means a significantly higher euro risk premium remains justified.

"This is because the threat of a gas shortage puts a double burden on the single currency. Even if rationing could be avoided, the economy faces a significant structural change away from cheap Russian gas, which will weigh on potential growth and return prospects in the euro area. At the same time, high gas prices are fuelling inflation and reducing the purchasing power of the euro," says Reichelt.

Looking to the European Central Bank's policy meeting, Commerzbank says the fate of the Euro hinges on how successful the ECB is in keeping inflation in check without unduly burdening the real economy with tight monetary policy.

"The ECB faces nothing less than a squaring of the circle. Against this backdrop, I consider sustainable euro gains to be unlikely," says Reichelt.

The Euro has gained against the Pound and Dollar this week partly as a result of reports out earlier in the week the European Central Bank could go with a 50 basis point rate hike this Thursday.

A 50bp hike would now be an unsurprising decision for investors and will therefore have limited impact on the single currency. Therefore the initial risk to Euro exchange rates is that the anonymous reports hinting at a 50bp hike are false and this week's gains are ultimately returned.

"Some disappointment will likely emerge if the ECB hikes by only 25bp, which remains our expectation," says Roberto Mialich, FX Strategist at UniCredit Bank.

Analysts warn however that it is the details of the ECB's anti-fragmentation tool that holds the most risk for the Euro.

The tool is the ECB's attempt to ensure the cost of servicing debt in some EU countries - most notably Italy - do not rise too rapidly.

There is a concern that rising interest rates at the ECB the cost of debt paid by various Eurozone countries will start to rise.

But higher debt repayments could mean some of the weaker Eurozone countries run into trouble, causing a fragmentation of the Eurozone which is ultimately a threat to the single currency itself.

"Ten years after Draghi’s pledge to do whatever it takes, Christine Lagarde risks repeating history. She must avoid drifting into another crisis that would ultimately require her to make a similar pledge to her predecessor," says Neil Shearing, Group Chief Economist, Capital Economics.

The broad expectation is that the ECB will simply buy the debt (sovereign bonds) of distressed countries, thereby capping their yield and ensuring costs remain contained.

But this form of quantitative easing is at odds with the ECB's desire to end quantitative easing altogether and raise interest rates in order to ensure inflation starts coming down.

The answer therefore would to be to buy specific bonds but suck liquidity out of the system elsewhere in a 'sterilisation' operation: this is the tricky bit and where nuances lie.

"We think the ECB will be deliberately vague by avoiding specific targets for yields or spreads," says Stephen Gallo, European Head of FX Strategy, BMO Capital, a lack of detail could still be interpreted negatively by the FX market."

The risk for the Euro is that any vagueness is interpreted by investors as a sign the ECB has failed to reach a credible solution.