EUR/USD Rate: Current Account Improvement Points to Ongoing Resilience

Above: A significant improvement in the Eurozone current account. Image: BNP Paribas, Macrobond, ECB.

The fall in global energy prices means the Eurozone economy is no longer paying out more than it earns in exports and is gaining net capital inflows, according to a number of institutional analysts who back ongoing strength in the Euro as a result.

This after new data revealed the Eurozone's current account has recovered and is back to pre-invasion levels.

"Eurozone balance of payments dynamics have been the key transmission mechanism through which energy price declines feed through to a stronger EUR and recent data we've gotten suggests a more supportive outlook for the EUR, consistent with our bullish medium-term targets," says Alexander Jekov, G10 FX Strategist, BNP PARIBAS.

Balance of Payments data for November from the European Central Bank showed the region's current account printed a surplus €13.6BN as it recovered from a deficit of €38BN in August.

The improvement was driven by both the trade balance, as energy prices declined, and the services balance improving.

At its simplest, a current account deficit implies the Eurozone is paying out more in foreign currency terms than it earns, thereby putting downward pressure on its currency.

Therefore November's data is consistent with an improved fundamental outlook for the Euro.

"We note that the eurozone's current account is now back to a surplus, which is a rapid rebound from the deficits recorded in summer 2022 that generated so much negative sentiment around EUR," says James Lord, an analyst at Morgan Stanley.

The Euro has risen by nearly 14% against the Dollar since it bottomed in September when the Euro to Dollar exchange rate (EUR/USD) quoted at 0.9535.

Morgan Stanley strategists are 'long' the Euro, and Lord says "perhaps positive sentiment can rebound equally quickly should the surpluses grow from here, which is possible given how far gas prices have fallen and the coming rebound in the Chinese economy that will help the exports position of the eurozone."

BNP PARIBAS is also bullish on the Euro's prospects as the region's Balance of Payment dynamics improve thanks to the current account entering a surplus.

"We think the combination of higher Eurozone bond supply, more attractive domestic yields and improving growth expectations as energy prices normalise, mean the trajectory for portfolio flows is likely to be one of further improvement. We expect Balance of Payments dynamics to continue to provide a tailwind flow for the EUR," says Jekov.

The normalisation of energy prices is the single most important driver of the Eurozone's improved prospects as the benchmark TTF benchmark contract has fallen more than 80% from August highs at 342 per megawatt hour.

Improvements are driven by a reduction in usage, strong LNG shipments, mild winter weather and increased wind power output. This has left European gas storage at an all-time high for this time of year, according to data this week.

Above: TTF wholesale gas contract for February delivery.

"The significant deterioration in the Eurozone's current account position appears to be stabilising," says Dominic Bunning, Head of European FX Research at HSBC.

HSBC expects that softening in oil and gas prices will ensure Europe's terms of trade continues to improve, helping to limit the decline in the goods balance.

"The services component may also be benefiting from relative EUR cheapness and could get a further boost from tourism in the middle of the year," he adds.

HSBC says it looks for ongoing strength in the Euro as the Eurozone's trade dynamics improve in the months ahead.

Analysts at Credit Suisse meanwhile hold a near-term target on the Euro-Dollar exchange rate at 1.0950, based on a view that European growth outcomes could come out better than expected.

Shahab Jalinoos, head of FX strategy at Credit Suisse, says a "positive terms-of-trade shift that has taken place on the back of falling energy prices".

Portfolio flows are also supportive of the Eurozone's single currency as investors redirect capital into the Eurozone, bidding up the Euro in the process.

HSBC research finds Eurozone bond yields are looking more attractive relative to U.S. counterparts than at any point in a decade.

This is a view shared by the team at BNP PARIBAS.

"Eurozone investors also continued to repatriate foreign equities. On the debt side, domestic investors are no longer buying foreign debt and we observe foreign investor inflows into eurozone debt," says Jekov.