In July 2012, the future of both the Eurozone and its currency looked decidedly cloudy. At the time, the European Central Bank’s chief Mario Draghi famously stated that “the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
While the single currency didn’t immediately start flexing its muscles, Draghi’s declaration helped hasten the end of the sovereign debt crisis and bolstered the market’s financial confidence. Since then the euro’s recovery has at times been eclipsed by a strong US dollar – even as recently as 12 months ago, there was talk of the two currencies reaching parity – but begins 2018 in good shape.
Underpinning the currency’s revival have been three main contributing factors.
- After recession in several key Eurozone member states and meagre growth in others since the 2008-09 global financial crisis, the Eurozone’s economic growth is finally moving into gear.
- The ECB’s massive quantitative easing (QE) programme, with over €2 trillion of government and corporate bonds purchased since 2015 has underpinned the recovery.
- Inflation remains subdued for the moment, still well below the ECB’s 2% target.
Turning the tables
While Europe’s economic picture has brightened, the recovery has lagged that of the US where the Federal Reserve promptly turned on the QE tap in response to the global financial crisis. By the end of 2013 the Fed felt able to begin winding down or ‘tapering’ its QE programme. By the end of 2015, it felt emboldened to start gradually hiking up interest rates again.
The dollar strengthened in response, helped further by post-Brexit uncertainty and fears on more potential upsets from last year’s elections in the Netherlands, France and Germany. From a rate of €1=$1.3779 in December 2013, it advanced to a high of €1=$1.039 in December 2016 as analysts predicted that parity was imminent.
Yet that proved to be the high point. By last September, the euro had regained a rate of $1.20 and recent months have maintained the story of euro strength versus dollar weakness.
A resurgent single currency has already begun to alarm some major European corporates. France’s cognac producer Remy Cointreau warned last week that the euro’s strength against the US and Chinese currencies was “very brutal” and would dent the group’s full-year profits, despite healthy sales.
Draghi is aware of these concerns – and the likelihood that more corporate profit warnings will follow in the coming weeks, says Phil McHugh, trading floor manager for FX broker Currencies Direct. He expects a softer tone from the ECB chief when its governing council meets on Thursday, even if that will probably do little to slow the euro’s upward trajectory.
“The ECB is looking to pursue normalisation and 2018 will be a major stepping stone,” says McHugh. “It means exiting the QE programme and – further ahead – policy tightening and rate increases. But it probably won’t be until the meeting in March that members confirm they’re looking to end QE.
“Meanwhile the markets are getting a little ahead of themselves and have already started pricing in normalisation.”