Euro-to-Dollar Rate Headed to 1.16 if Germany's SPD Reject Coalition - Morgan Stanley

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Markets are expecting a coalition would see increased government spending and another bout of “European integration”, with both being positive for growth, but an SPD rejection would scupper this.

The Euro-to-Dollar rate could fall to three month lows Monday if the membership of Germany’s Social Democratic Party reject a coalition with Chancellor Angela Merkel’s Christian Democratic Union Sunday, according to Morgan Stanley.

However, such an outcome should be viewed by speculators as a strategic and long term buying opportunity, which might help to ensure that any sell off is arrested quickly once into the new week.

Morgan Stanley flags that markets are expecting a coalition would lead to increased government spending in Germany and another bout of political and economic integration in Europe, which is hailed as positive for economic growth.

Rejection of a coalition by the SPD would place a question mark over all of this, while casting the Eurozone’s largest economy out into a sea of fresh political uncertainty that could ultimately lead to another election.

“A recent poll indicates that 56% of SPD members would approve a coalition, which is what we are expecting,” says Hans Redeker, head of FX strategy at Morgan Stanley.

“If on the other hand the SPD rejects the coalition proposal, we expect EURUSD to fall to 1.16/1.17 in which case we would be long-term buyers of EUR.”

A fall below 1.17 and into the 1.16 area will put the Euro-to-Dollar rate at its lowest level since the beginning of November 2017 and would amount to a 5% decline from Friday’s 1.2317 level. This would reduce the 12 month gain of EUR/USD to a little over 12%.

The SPD vote in Germany comes after Chancellor Merkel struck a deal last month for her Christian Democratic Union (CDU) party to form a coalition government with the opposition.

Recent polling suggests dissatisfaction among members over the deal and so there is a chance it could be rejected, which would mean a weak minority government in Germany, or fresh elections.

Support for the SPD was recorded at an all time low of 15.5% at the end of February, down from 21% before and immediately after the September 2017 election, relegating it to third place behind the Alternative fur Deutschland in the league table of Germany’s largest parties.

Germany's SPD shed 2 full percentage points in polls between the end of January and the end of February alone, with losses deepening as more details of the coalition emerged.

The result of the SPD vote will become known on the same day that Italians head to the polls to choose their next government. Almost all parties vying for electoral support have made pledges that will place Italy on a collision course with Brussels over public spending and the nation’s budget deficit.

The Five Star Movement, Italy’s largest political party and a growing anti-establishment force, has pledged to renegotiate European rules on budget deficits and austerity. It has floated the idea of a referendum on Italy’s continued use of the Euro in the event the negotiation fails.

“Our economists’ base case is for no party/coalition to win enough seats to govern alone,” says Redeker.

“The election will likely be followed by a protracted period of negotiations which could have short-term impacts on the EUR, but we believe the Italian election is unlikely to have a lasting impact on global growth and risk sentiment and hence limited long-term implications for the common currency.”

The Euro-to-Dollar rate was quoted 0.36% higher at 1.2317 shortly ahead of noon Friday. It has risen 2.7% in 2018 and is up by 17.2% over the last 12 months.

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