Euro weakness pressured by stronger dollar and growth pessimism
Euro Currency Report -October
Derbyshire, UK – October 16th, 2023 - This is the currency report for the Euro and is intended to be a reference aid for your own analysis and trade planning. This update contains the latest data for retail sales which are reflective of a slowdown and unemployment which remains steady. The next update will be after the EA inflation data on Wednesday, October 18th, or before if any significant event occurs.
Decisions to trade are made at your own monetary risk.
Euro weakness pressured by stronger dollar and growth pessimism
ECB hikes interest rates to combat inflation, dampening economic growth. The economic outlook for the European Union is mixed, with growth slowing but a recession possible. Unemployment is stable, but the Russia-EU gas dispute and the war in Ukraine are adding uncertainty to the global economy.
Monetary Policy
The European Central Bank (ECB) has been raising interest rates in an effort to combat high inflation. The latest hike was 0.25% in September, bringing the main refinancing operations rate to 4.50%. This hawkish stance is likely to dampen economic growth, which is now expected to be 0.7% in 2023. However, the ECB is committed to bringing inflation back to its 2% target, and will keep interest rates at restrictive levels for as long as necessary. The economy is slowly growing, but there is a mixed outlook for the future. Annual real GDP is expected to contract, while annual HICP is expected to come in below expectations.
Interest Rates Hiked, ECB Target Inflation Over Growth
The six members of the European Central Bank’s (ECB) Governing Council (plus nineteen governors from the national banks of the countries using the euro) set monetary policy, including the Main Refinancing Operations rate (interest rate). The main refinancing operations rate is the interest rate that banks pay to borrow money from the ECB overnight and is secured by bonds. This rate affects the interest that banks charge their borrowers.
The governing council meets to set monetary policy eight times a year, the latest was September 14th and the next is on October 26th.
The interest rate of the EA was hiked at the September meeting by 0.25% after also being hiked by 0.25% in August and throughout almost all of the previous twelve meetings. This indicates that the ECB is hawkish and is focused on stamping out the high rate of inflation. Trading Economics forecast 4.50% to be the peak rate and 2024 to see cuts of 0.75%.
Key points of the ECB’s Governing Council September 2023 meeting:
Raised its key interest rates by 25 basis points in order to bring inflation back to its 2% medium-term target.
Expects inflation to average 5.6% in 2023, 3.2% in 2024 and 2.1% in 2025.
Rate increase is likely to dampen economic growth, which is now expected to be 0.7% in 2023, 1.0% in 2024 and 1.5% in 2025.
Will keep interest rates at restrictive levels for as long as necessary to bring inflation back to target.
Sources: European Central Bank, Macroeconomic Projections, Trading Economics, FXStreet
The Economy is Slowly Growing but has a Mixed Outlook
The ECB’s Governing Council makes macroeconomic projections four times a year. The most recent was at their September meeting and they will be updated in November.
Annual Real GDP has a pessimistic outlook compared to the Governing Councils forecast and shows a contraction is likely.
Annual HICP has an optimistic outlook compared to the Governing Councils forecast and is on track to come in below expectations.
Market Narratives
Resilient US Economy is applying bearish pressure to the EUR/USD
The EUR/USD has gained and lost value in a contrarian correlation with US inflation rates which peaked in late 2022. The current downtrend of the EUR/USD formed in July 2023 when investors began to reposition for the likelihood that the Fed will keep rates higher-for-longer due to the US economy being more resilient than anticipated.
In the previous month, the EUR/USD has advanced this downtrend as economic indicators support the "Resilient US Economy" narrative.
Downside moves have the potential to test the support area ≈$0.960 while upside retracements could climb to test the 50-day average price of ≈$1.070.
Economic Indicators
The economic outlook for the European Union is mixed. Growth is slowing, but there are signs that a recession may be avoided. Inflation is also falling sharply, but retail sales are declining. Unemployment is stable, which is a positive sign. Overall, the outlook is uncertain, but there are some positive trends.
Outlook for Growth Shows that Slowing Economy May Rebound
The EA GDP quarterly rate report measures the change in value of goods and services produced in the EA over a given month compared with the previous. The latest data covers the Q2 period and was published on September 7th by Eurostat and the next version is out on October 31st.
The quarterly rate of GDP in the EA has been falling quickly over the past four months although recently rebounded, after being mostly neutral for the previous year. This indicates that the economy is slowing and is at risk of recession.
The Q2 growth rate of 0.10% was higher than Q1’s -0.10%, and bucked the recent downtrend. The forecasting model predicts 0.2% growth during Q3, which would also be above the recent downtrend and suggests that a recession could be avoided. Trading Economics are far more optimistic, with a forecast of 0.4%.
Sources: Eurostat, Trading Economics, FXStreet
Outlook for Inflation Signals that growth will be pressured
The EA inflation rate report measures the change in value of a basket of goods and services in the EA over a given month compared with the previous. The latest data covers the September period and was published on October 18th by Eurostat and the next version is out on October 31st.
EA prices have been steady over the past four months although recently fell sharply, continuing the rapid fall of the previous year. This suggests that the economy is slowing down, as demand falls and businesses compete for fewer customers. However, it could also be a sign that supply chains are improving.
Inflation in September (4.3%) was far lower than August (5.2%). The trend-following forecasting model predicted 5.0% for September so the result of 4.3% which is far lower than the 5.2% in August shows that the fall is picking up speed. If this pace is to continue then the forecast would be 4.6% for October. Trading Economics are optimistic with their forecast of 3.6% by the end of Q4.
Sources: Eurostat, Trading Economics, FXStreet
Outlook for Retail Sales Signals a Light Headwind to Growth
The EA retail sales report measures the change in value of aggregated retail goods and services sales over a given month compared with the previous. The latest data covers the August period and was published on October 4th by Eurostat and the next version is out on November 8th.
EA sales have significantly declined over the past four months, reversing the volatile but flat trend seen over the previous year. This is a sign of a slowing economy, as consumers tighten their belts amid the cost of living crisis and rising interest rates.
August sales (-1.2%) showed a deterioration over July (-0.10%) and fell far below the recent downtrend. The trend-following forecast model incorrectly predicted sales of 0.0% for September and is now forecasting sales of 0.5% for October. Trading Economics are even more optimistic, with a forecast of 0.6% by the end of Q4.
Sources: Eurostat, Trading Economics, FXStreet
Outlook for Unemployment Signals a Calm Tailwind to Growth
The EA unemployment rate report measures the number of people actively looking for a job as a percentage of the labour force over a given month. The latest data covers the August period and was published on October 2nd by Eurostat and the next version is out on November 3rd.
EA unemployment has been stable over the past four months, continuing the stable trend seen over the previous year. This is a sign of a stable economy, as businesses maintain employment levels.
August’s unemployment of 6.4% matched July’s 6.4% in line with the flat trend. The trend-following forecast model correctly predicted 6.4% for September and is now forecasting 6.2% for October which seems too optimistic. Trading Economics have a forecast of 7.0% by the end of Q4.
Sources: Eurostat, Trading Economics, FXStreet
Geopolitical Events
The Russia-EU gas dispute has caused significant disruptions to gas supplies to Europe. This has led to soaring gas prices, which are putting upward pressure on inflation. The war in Ukraine has also added uncertainty to the global economy, and is weighing on the euro area economy.
Russia-EU Gas Dispute Applies Upwards Pressure to Inflation
The Russia–EU gas dispute flared up in March 2022 following the invasion of Ukraine. Russia cut the flow of gas to Europe significantly, and in September 2022, it stopped it altogether. As of August 2023, Russian pipeline gas exports continued to flow to some EU countries and non-EU countries in Europe, but the flow was significantly reduced from pre-war levels. Europe also imported record volumes of liquefied natural gas (LNG) from Russia in 2022.
Recent Key Events
Russia has cut gas supplies to Europe significantly since April 2022, and stopped them altogether to Poland, Bulgaria, Finland, and Ukraine.
Russia has also reduced gas flows via the Nord Stream 1 pipeline, citing technical difficulties.
In September 2022, the Nord Stream 1 and 2 pipelines ruptured, likely due to sabotage.
European countries have been working to secure alternative gas supplies, including from Norway, Qatar, and the United States.
EU gas prices have soared in response to the disruptions, but have fallen in recent months as storage levels have increased.
The gas delivery disruptions have had a significant impact on the European economy, as gas is a key source of energy for many industries and households.
Russian Invasion of Ukraine Adds Uncertainty
On February 24, 2022, Russia invaded Ukraine in an escalation of the Russo-Ukrainian War which began in 2014. The invasion is the largest military conflict in Europe since World War II and has resulted in tens of thousands of casualties on both sides. The invasion has also caused a humanitarian crisis, with millions of Ukrainians displaced from their homes. The international community has condemned the invasion and imposed sanctions on Russia. The International Criminal Court is investigating possible war crimes and crimes against humanity committed by Russian forces.
Recent Key Events
June 2023: The Ukrainian counteroffensive in June 2023 made significant progress, with Ukraine liberating villages and reclaiming territory in the eastern Donbas region. The Wagner Group's rebellion against the Russian government was a major setback for Russia.
August 2023: Ukraine counteroffensive slowed by millions of mines laid by Russia. Ukrainian drones damage the Russian landing ship Olenegorsky Gornyak.
September: An attack on Russian naval targets in Sevastopol damages the Black Sea fleet. Several oil and gas drilling platforms on the Black Sea held by Russia since 2015 have been retaken.
The war in Ukraine is having a negative impact on the global economy, including the value of the Euro. The war has caused energy prices to soar and disrupted supply chains, which are putting upward pressure on inflation and weighing on the EA economy.
Gavin Pearson
Retail trader since 2008
Specialises in forex G7 currencies
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Regular contributor to FXStreet.com analysis and education pages
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