Analysis: Big rate hike won’t save the euro as energy shock deepens

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Euro banknotes are seen in this illustration taken July 17, 2022. REUTERS/Dado Ruvic/Illustration

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LONDON, Sept 6 (Reuters) – The blow to the eurozone economy and its currency from a deepening energy crisis is so severe that more aggressive monetary tightening by the European Central Bank won’t do much. -thing to stop the fall of the euro.

The euro fell below $0.99 on Monday for the first time since late 2002 after Russia cut off natural gas supplies through the main pipeline to Europe, sending oil prices soaring. energy and heightening fears of a supply shortage. Read more

The weakening currency will be the focus of the European Central Bank’s meeting on Thursday, as a weak euro – down 13% in 2022 – could worsen already record inflation thanks to more expensive imports.

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Euro weakness adds to ECB inflation puzzle

Some politicians have said the bank needs to pay more attention to the euro than in previous periods of weakness because the price of gas is in dollars and a weak euro amplifies the effects of soaring energy costs. .

Money markets are pricing an 80% chance of an oversized 75 basis point rate hike this week, but analysts believe that would do little to help the currency.

“This sharp rate hike will do nothing to save the euro. A recession is looming and geopolitical concerns are out of control,” said Agnes Belaisch, strategist at Barings Investment Institute. “In fact, there’s a good chance that rising interest rates will coincide with inflation and recession in 2023.”

Goldman Sachs predicted on Monday that the euro will weaken to $0.97 and stay there for the next six months as demand destruction, caused by the gas crisis, leads to “a deeper and longer contraction.” .

Capital Economics revised its forecast to $0.90 for next year, down 9% from current levels.

The euro has been inversely correlated to gasoline prices for months, meaning it tends to fall when energy prices rise. Gas prices soared 255% in 2022 and on Monday jumped 30%.

RECESSION WATCH

The eurozone is almost certainly entering recession, with business activity contracting for a second month in August. Read more

The energy shock is taking its toll, while data suggests speculators have increased their bets against the currency. Read more

Euro Short Positions Build

UniCredit estimates that in the five years preceding the COVID-19 pandemic, the EU imported around €400 billion worth of oil and gas per year.

If oil prices remained at 100 dollars a barrel, the euro at parity and natural gas prices at 100 euros – five times more than the average of the last five years – the cost would rise to 600 billion euros, or 6% of GDP, calculates UniCredit. Erik Nielsen.

Economists and currency analysts believe that the economic difficulties will be even more severe than expected just a few months ago.

“The eurozone narrative is changing. A few months ago it was: ‘There will be no recession. the Institute for International Finance, said on Twitter on Monday. “This weekend we started to take the final turn: ‘we’re heading into a deep recession. The euro is going to go down a lot more.’

Still, some say the ECB could at least block the euro’s depreciation with big rate hikes in the coming months.

“The ECB can arguably help slow euro weakness, but it’s not clear that it can lead to sustained euro appreciation,” said George Saravelos, global head of equity research. foreign exchange at Deutsche Bank.

INFLATION PAIN

The euro suffered much less against other currencies than against the dollar, and the pound was also not supported by a build-up in expectations of a more aggressive rise.

A trade-weighted index closely watched by the ECB last month fell to its lowest since February 2020, but was lower throughout 2015 and 2016 without ECB intervention.

Nor is the impact of a falling euro on inflation as big as many think, said SwissRe’s head of macro strategy Patrick Saner. He cites official data to show that a 10% decline in the nominal effective exchange rate of the euro leads to an increase in consumer price inflation of 40 to 100 basis points a year later.

But as Saner notes, “even marginal effects aren’t exactly ideal right now.”

Inflation has been driven by energy prices, so European producer prices are soaring.

Deutsche Bank’s Saravelos points out that the effective euro exchange rate based on consumer price inflation is near a record high, but the index based on producer prices is close to a record level.

This means that the competitiveness of the Eurozone is rapidly weakening – a terms-of-trade shock that will further hurt the economy.

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Reporting by Tommy Reggiori Wilkes and Dhara Ranasinghe Editing by Tomasz Janowski

Our standards: The Thomson Reuters Trust Principles.

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