The euro is showing lows over the past two decades, going down ever lower to the mark when the rate of the two major currencies will equalize. If a month ago this scenario looked fantastic, now more and more voices are in favor of this scenario. We understand.
The euro's decline below parity against the dollar: the obvious - the incredible?
Positive news allows the EUR\USD pair to keep a precarious balance at the psychological level of 107 points. At the same time, the news itself cannot be said to be strongly positive.
Thus, inflation in Germany, the flagship among the European "ships", has reached another record high level. Figures released on May 30 showing rising energy and food prices showed that domestic consumer prices jumped 8.7% from a year earlier in May. Analysts missed by six-tenths of a point, forecasting an increase of 8.1%.
No better is the news from Spain, which reported an acceleration in price growth - up to 8.5% in May from 8.3% in April, which in turn was caused by rising fuel prices, due to which the decline in energy costs was offset. Underlying price growth, excluding food and energy, accelerated to 4.9%.
Interestingly, against the backdrop of rising prices, the statistical offices of individual eurozone countries are reporting a decrease in inflation expectations and an increase in consumer confidence. Only Belgium, Latvia and Cyprus go against the general mood, demonstrating buying pessimism. And this is against the backdrop of phenomena such as demonstrations in France, caused by a decrease in purchasing power.
Spain copes best with the mood of the residents, which promptly introduced a number of measures to regulate electricity prices and continues to work actively in this direction. Germany has also adopted a subsidy package that includes child support, lump-sum family allowances and compensation for energy costs. However, these measures appear to be insufficient.
Overall, the figure from the European Commission rose to 105 in May from a revised reading of 104.9 in April. Meanwhile, economists had expected a decline to a 14-month low.
Positive sentiment was driven by the services and construction sectors, which posted surprisingly strong gains in May.However, this is a very temporary optimism, which may turn against the bulls tomorrow, after the publication of the consolidated report. These figures are expected to show prices in the euro area have jumped to 7.8% this month, another all-time high.
Immediate prospects
Indeed, the Russian-Ukrainian conflict undermines the stability of the entire eurozone. The region's cost-of-living crisis is deepening and has yet to reach its peak.
For example, economist Friederik Heinemann noted that households are likely to have to reckon with further price increases, because many resources are still in short supply, and wholesale prices are still in a phase of sharp growth.
And don't be fooled by the surprisingly good labor market data. In fact, they also indicate that the dreaded self-rewinding spiral of wages and prices may soon pick up speed as well, provoking the region's economy into stagflationary stagnation.
Germany, for example, even reduced the salary fund by 1.8% (adjusted for inflation). All the more, Germans feel the pressure of prices, as wages less and less compensate for the gap between the rise in the cost of goods and wages.
All this makes the markets increase their expectations of the more hawkish policy of the European Central Bank.
Previously, analysts' forecasts were reduced to an increase in base interest rates by 0.25%. However, the confidence that rates will rise by half a percentage point is growing along with the data of the reports.
The ECB in full force now resembles a hero in front of a stone of fate at a crossroads: if you greatly increase rates, you will lose production due to the lack of cheap loans; if you leave rates low, inflation will continue to unwind... pulling both production and consumer demand with it.
Obviously, the solution lies in the field of individual assistance packages for various industries, which will thereby be able to increase wage funds without increasing the prices of products. However, two years of cheap money, which helped both those who needed it and those who didn't, exhausted the feeder and now there is simply nothing to help.
In addition, the governments of the European coalition are in no hurry to support producers, focusing on helping households.For example, Italy has budgeted around 6 billion euros to protect low-income workers from the effects of inflation by offering them a lump sum of 200 euros.
France has been more forward-thinking in its support of manufacturers, allocating some 25 billion euros in anti-inflation measures, including grants for energy-intensive companies, an expansion of state-guaranteed lending and additional funding for holidays. Other initiatives include price caps on electricity and natural gas, gas and diesel rebates for motorists, fuel subsidies for fishermen, and checks for millions of households. The statistical office Insee estimates that such measures have reduced inflation by about 1.5 percentage points.
But all this will not save the eurozone if relations with Russia lead to a full-blown fuel and energy crisis. The situation is aggravated by the different approach to the Ukrainian-Russian conflict among the EU members. Some are inclined to support Ukraine at any cost, abandoning Russian energy sources entirely. Others try to sit on both chairs, giving hope to both sides and not taking pronounced steps in either direction. The saddest part is that Germany is one of the latter.
At the same time, both options are capable of putting an end to the confrontation between the two Slavic countries, however, half-heartedness confuses the leaders of these countries, forcing them to rely unreasonably on contracts and promises of Europeans. The vague policy rebounds on the eurozone itself, leaving the rest of the world to wonder how much support will still be provided to Ukraine and futures for Russian gas purchased.
With this in mind, the prospects for early autumn this year look rather bleak. Especially against the background of the fact that the dollar is strengthening quite independently of the euro.
The main partner is strengthening at a frantic pace
In addition to its status as the world's reserve currency, there are three main reasons why the dollar continues to appreciate despite the ominous economic performance.
The first factor we have already considered is the conflict between Ukraine and Russia.
Secondly, the market is supported by relative growth expectations: the red-hot US economy recovered from the pandemic much faster, and is expected to grow faster than in the euro area, even taking into account inflation (and at first, thanks to it).
Finally, let's not ignore relative interest rate differentials. The Federal Reserve flew out of the dove's nest much faster (and in a timely manner) with its 75 basis point gain. It helped that the start came from a higher base, albeit with a higher marked path for future growth, which should not add optimism to investors, but also has a calming effect.
But the ECB is still hesitating whether to finally raise the deposit rate by 50 basis points before central banks go on summer break. The bank is also still buying bonds, continuing to replenish its huge quantitative easing cauldron.
It is impossible not to notice that the EU was late in raising rates. And now that inflation is already causing the first turmoil, although it is still far from its peak, it is too late to tighten monetary policy. Now, more than ever, manufacturers need support.
Such a major miscalculation would cost the European economy dearly.
Euro is worth more
This barrel of tar contains a small but important spoonful of honey.
When the euro traded at less than one dollar at the beginning of the century, it was largely due to the existential risk that the new single currency project could easily fall apart. But now the eurozone is facing an external threat, and although imported inflation of this magnitude is harmful, it is perceived as a collective problem and does not induce the population of the member countries to demand an exit from it.
Many experts note that today the single currency is undervalued in almost all respects. For example, you can look at the Purchasing Power Parity of the International Monetary Fund, which estimates a fair value of $1.45 per euro, a far cry from the current market rate of forty cents lower.
Such situations are found in the international monetary fund. According to Keynesian economics, currencies can remain irrationally expensive or cheap for long periods of time.
The experience of 2017 shows us that the euro tends to pick up the missing points quickly as the economic situation levels off.
This forecast is also influenced by the degree of closeness of China, where many European productions are located. The first signs of quarantine easing that come to us from Beijing have a positive effect on the exchange rate of the entire currency basket.
However, there is no guarantee that the Chinese government will not start hunting for test-positive "witches" again. And this uncertainty will worry eurozone producers throughout 2022, leading to operational errors in the form of excess stocks in the warehouse, or vice versa, problems with raw materials and imported goods from the Asian region.
As a result, the uncertain policy of the ECB and macroeconomic factors can lead the euro to fall below parity with the dollar. The pound, having entered a bearish dive, is able to pull the euro as well.
But this is likely to be a short-term situation that will improve by the end of the year if the conflict in Eastern Europe is resolved or does not turn into a positional war, as it has been for the past eight years, and the likelihood of one of these two scenarios is very high.
At the same time, trench warfare on the outskirts of Europe will not allow its currency to start a bullish rally with confidence when the time comes for the growth of the global economy. And its future prospects will seriously depend on this factor.
