The euro soars: that’s why the common currency will continue to rise

SIt only lasted a few seconds. But the symbolism was of great importance. When the euro briefly crossed the $ 1.20 mark again on Tuesday for the first time since early 2018, it became clear to the latter that a drastic shift was taking place in the currency market. Suddenly: euro hui, dollar ugh. And that’s after years of strong dollar.

It is the latest highlight of a development that has been going on for several months. Since mid-May, the euro’s exchange rate has gone from $ 1.08 to $ 1.20, an appreciation of 10 percent in just a few weeks. And this is far from over, in the coming months, according to many experts, completely different brands will be surpassed. Because the common currency is being driven by a number of positive factors and is experiencing a moment of happiness in a sense.

As pleasant as it may seem at first glance, it is equally troublesome for the German economy. You can still take the recent appreciation, but at a certain point that will change, especially in the current situation. So the question is whether the European Central Bank can and will intervene.

The appreciation of the euro happened too fast

On Tuesday it did it punctually, it barely raised 1.20. The exchange rate is important to the ECB’s policy, announced its chief economist Philip Lane: a banality, but the statement immediately diverted the course. Sometimes it fell below $ 1.18. But that doesn’t necessarily have to last long.

The appreciation of recent months has happened too quickly, says Kit Juckes, a currency expert at investment bank Société Générale. “But it seems clear to us that we are at the beginning of a multi-year phase of the dollar’s decline.” Therefore, the mark of $ 1.25 per euro will be reached in the next twelve months. This is also what the currency experts at Goldman Sachs say as a goal. Japanese bank Mizuho even expects $ 1.30 for July 2021.

One of the main reasons for this is outside of Europe, in the US Because in response to the Crown crisis, the US central bank slashed interest rates and at the same time went back to making massive bond purchases. . As a result, the real interest rate, interest minus inflation, is now negative in the US, and investors don’t expect that to change anytime soon.

This can be seen in the yields of US government bonds linked to inflation. Your interest rate adapts to inflation, and here yields have fallen from plus one to minus one percent since the beginning of the year; In other words, investors also expect negative real interest rates in the future. This means that the interest rate gap with the Eurozone has narrowed dramatically and that one of the main reasons to invest in the US has ceased to exist.

At the same time, the United States government is taking on unprecedented levels of debt. “US debt has already reached proportions that will significantly limit the scope of the policy in the future,” says Ivan Mlinaric, managing director of investment company Quant Capital. That undermines confidence in the dollar.

At the same time, the US government is failing to strengthen the economic base. Because the economic crisis will not end there. Consumer confidence, measured monthly by the Conference Board research institute, fell again in August and, more importantly, expectations for the future are even below the previous low in April.

Very different on this side of the Atlantic. In Germany in particular, the outlook is brightening up significantly. Last week, for example, the federal government revised up its economic forecast for this year. Instead of a 6.3 percent drop, you now expect a 5.8 percent decline. Federal Minister of the Economy Altmaier even hopes that an “even slightly better result” is possible.

Commerzbank chief economist Jörg Krämer also blew his forecast on Friday. In any case, he has always been a bit more optimistic, forecasting a 5.5 percent drop in gross domestic product in May. “Since then, the economy has recovered significantly and there is a very strong increase of nine percent in the third quarter compared to the second,” he says. So he has now raised the forecast for the full year to minus 4.5 percent.

But optimism is spreading in the rest of the euro zone as well. “The economic recovery in most other euro countries also continued in August,” write the Bantleon bond investor economists in a recent analysis, “and there are also signs that the uptrend will not stop in the fall.” They want their forecast, therefore, to revise upwards for the euro zone as soon as the final figures for the second quarter are available. Krämer has already done so and now predicts less than 6.5 percent for the euro zone instead of the previous seven percent.

And this momentum will continue into the coming year, believes Johannes Müller, head of the forecasting team at fund company DWS. “The euro zone is likely to see a rebound in 2021 with the help of the reconstruction fund, which will support growth in the most affected countries, especially Spain and Italy, starting in the second quarter of 2021,” he says.

The forecast for the United States, however, is made with great reservations. “The pandemic was never really under control due to the rapid reopening,” says Müller. “Due to the political stalemate in Washington, some fiscal support measures have not been extended and consequently have clouded the economic mood.”

The rating agency Moody’s sees it in a similar light. The economic recovery in the euro zone has a stronger foundation than in the United States or Great Britain. They also cite the rebuilding fund as a major reason for this. And economists at investment bank Goldman Sachs write: “We assume that the euro area economy will outperform other countries.” Therefore, they assume that the euro is currently undervalued.

Therefore, there are several events that are driving the euro exchange rate higher: the economic weakness of the US and the low interest rates there, on the one hand, and, on the other, the relative economic strength and the agreement politician on a joint reconstruction fund in the euro zone. Therefore, in turn, the exchange rate of the euro is not only rising against the dollar. The euro index, which compares the euro to 20 other currencies, has reached a multi-year high in recent weeks.

This is already having very specific effects on the German economy. “According to our statistical estimates, the previous appreciation of the euro against the currencies of the main trading partners suggests a fall in gross domestic product of a quarter of a percentage point,” says Commerzbank chief economist Krämer. Ludovic Subran, chief economist at Allianz, has calculated that a sustained appreciation of the euro of 10 percent will lead to a drop in growth of around 0.2 percentage points.

However, Krämer also points out that this is insignificant compared to the accident caused by the pandemic. And Subran objects that about 60 percent of German companies’ exports go to other EU countries, where most accounts are invoiced in euros. Furthermore, the weak dollar also means that raw materials and intermediate products can be bought cheaper.

After all, the current exchange rate of $ 1.20 per euro is roughly in line with the long-term average and is therefore not a problem, says Stefan Bielmeier, chief economist at DZ Bank. “If there are temporary problems, it is only because the update was done very quickly,” he says.

But that appears to be exactly the ECB’s fear, which is why its chief economist, Philip Lane, weighed in last week. After all, a ten percent appreciation in the currency market in about three months is an unusually fast trend reversal. Also, the 1.20 mark in central bank boardrooms is an important threshold. “In the past, breaking the 1.20 mark has led to announcements of new measures, in particular interest rate cuts,” says Subran.

The big question that could be answered in the next week is whether that will be the case this time as well, and whether words will be followed by deeds. The ECB Council meets in Frankfurt on Thursday and the Eurogroup finance ministers meet in Berlin the next day. However, Subran still does not believe in new measures.

Especially since they don’t have too many options. Virtually all experts rule out a new rate cut, the key interest rate is already zero, the deposit rate that banks have to pay is even less 0.5 percent. Even lower negative interest rates would only harm the banking system.

Only the increase in bond purchases remains. Subran believes this is likely, provided deflationary trends do not abate in December. But then the end of the story would gradually be reached and the way to the upside would open for the euro. But Subran also believes that it would end at 1.30 euros at most. “Because the associated deterioration in the euro zone economy should lead to a self-correction of the exchange rate.” This is where the trend would reverse at the latest and the euro would end its lucky streak.