Political Turmoil and Economic Uncertainty Weigh on the Single Currency, with French Elections (July 7) Looming
Monday, 24 June, Week 26: The Euro has faced a turbulent five months, grappling with political instability in France and a mixed economic picture. While the European Central Bank (ECB) recently cut interest rates, concerns about the Eurozone's economic outlook and the potential for further political turmoil in France are likely to weigh on the single currency in the coming weeks. This report will delve into the key factors influencing the Euro's trajectory, providing a comprehensive analysis of its prospects in the near term.
Currency
The Euro has been under downside pressure for the past five months, largely due to a combination of political uncertainty in France and a mixed economic picture in the Eurozone.
February - April 2024: The Euro initially showed resilience, supported by expectations of further interest rate hikes by the ECB. However, political turmoil in France, triggered by President Macron's decision to dissolve the National Assembly following a heavy defeat in the European Parliament elections, began to weigh on the single currency.
May 2024: The Euro continued to weaken as concerns about the Eurozone's economic outlook grew. Despite the ECB's interest rate hikes, inflation remained stubbornly high, and economic growth slowed. The single currency also faced pressure from a strengthening US dollar, driven by expectations of a more hawkish Federal Reserve.
June 2024: The ECB surprised markets by cutting interest rates by 25 basis points on June 6, citing an improved inflation outlook and easing underlying inflation. However, the Euro's reaction to the rate cut was muted, as investors remained concerned about the Eurozone's economic prospects and the potential for further political instability in France.
Looking ahead to the next five weeks: The Euro's trajectory will likely be determined by the outcome of the French legislative elections scheduled for July 7. A fragmented National Assembly or a far-right victory could further undermine confidence in the Eurozone and weigh on the single currency.
Other factors that could influence the Euro in the coming weeks include:
The ECB's monetary policy stance: The central bank's future interest rate decisions will depend on incoming economic data, particularly inflation and growth figures.
The evolution of the war in Ukraine: The conflict continues to pose significant risks to the Eurozone economy, particularly through its impact on energy prices and supply chains.
The strength of the US dollar: The Euro often moves inversely to the US dollar, so a continued strengthening of the greenback could put further pressure on the single currency.
Fiscal Policy
The Eurozone's fiscal policy is currently in a state of flux, with governments grappling with the need to balance fiscal consolidation with support for economic growth. The withdrawal of energy and inflation support measures, implemented in 2022 and 2023, is expected to tighten the fiscal stance significantly in 2024. However, governments are also facing pressure to increase spending on areas such as defense, climate change mitigation, and social welfare.
The ECB, in its June 2024 macroeconomic projections, notes that "the withdrawal of fiscal support measures introduced since 2022 to compensate for high inflation and energy prices will, overall, have a small negative impact on growth in 2024-26." However, the report also highlights that "government consumption and investment will contribute positively to GDP growth."
The outlook for fiscal policy in the next five weeks is uncertain, as governments will need to respond to evolving economic conditions and the outcome of the French elections. A fragmented National Assembly in France could make it difficult to pass meaningful fiscal reforms, potentially leading to further uncertainty and market volatility.
Economics
The Eurozone economy is facing a number of challenges, including high inflation, slowing economic growth, and geopolitical uncertainty.
Economic Growth
The Eurozone economy grew by 0.3% quarter-on-quarter in the first quarter of 2024, following two consecutive quarters of contraction. However, the ECB's June 2024 macroeconomic projections suggest that growth will remain subdued in the near term, with annual average real GDP growth expected to be 0.9% in 2024.
The outlook for economic growth in the next five weeks is uncertain, as the Eurozone economy faces a number of headwinds, including:
High inflation: Elevated inflation is eroding consumer purchasing power and weighing on business investment.
Tightening monetary policy: The ECB's recent interest rate hikes are starting to have a negative impact on economic activity.
The war in Ukraine: The conflict is disrupting supply chains, pushing up energy prices, and weighing on business confidence.
Labour
The Eurozone labour market remains resilient, with the unemployment rate falling to a record low of 6.4% in April 2024. However, the pace of job creation is expected to slow in the coming months, as economic growth remains subdued.
Price Changes
Inflation in the Eurozone remains elevated, with the Harmonized Index of Consumer Prices (HICP) rising to 2.6% in May 2024. However, the ECB's June 2024 macroeconomic projections suggest that inflation will moderate in the coming months, with annual average headline HICP inflation expected to decline to 2.5% in 2024.
Trade
The Eurozone posted a trade surplus of €15 billion in April 2024, driven by a surge in exports. However, the outlook for trade is uncertain, as the global economy slows and geopolitical tensions remain elevated.
Monetary Policy
The ECB cut interest rates by 25 basis points on June 6, 2024, marking its first rate cut since September 2023. The central bank cited an improved inflation outlook and easing underlying inflation as justification for the move. However, the ECB also stressed that it remains committed to ensuring inflation returns to its 2% medium-term target in a timely manner and that it will keep policy rates sufficiently restrictive for as long as necessary.
The ECB's monetary policy stance in the next five weeks will depend on incoming economic data, particularly inflation and growth figures. If inflation continues to moderate and economic growth remains subdued, the central bank could cut interest rates again. However, if inflation proves to be more persistent than expected, the ECB could keep rates on hold or even raise them again.
Geopolitics and Market Themes
French Legislative Elections
Synopsis: France will hold the second round of its legislative elections on July 7, following President Macron's decision to dissolve the National Assembly in May. The elections will determine the composition of the lower house of parliament and will have significant implications for the country's political and economic direction.
Key Developments:
President Macron's centrist coalition is facing a strong challenge from a left-wing alliance led by Jean-Luc Mélenchon.
The far-right National Rally, led by Marine Le Pen, is also expected to make gains.
Polls suggest that the elections could result in a hung parliament, making it difficult for Macron to pass legislation.
Market Impact:
Uncertainty surrounding the election outcome is weighing on the Euro and French government bonds.
A fragmented National Assembly or a far-right victory could further undermine confidence in the Eurozone and lead to increased market volatility.
War in Ukraine
Synopsis: The war in Ukraine continues to pose significant risks to the global economy, particularly through its impact on energy prices and supply chains.
Key Developments:
Russia's invasion of Ukraine has led to a surge in energy prices, particularly for natural gas.
The conflict is also disrupting supply chains, leading to shortages of key inputs and pushing up prices for a wide range of goods.
The war is weighing on business confidence and investment, particularly in Europe.
Market Impact:
The war in Ukraine is contributing to high inflation and slowing economic growth globally.
The conflict is also increasing market volatility and uncertainty.
US Dollar Strength
Synopsis: The US dollar has been strengthening in recent months, driven by expectations of a more hawkish Federal Reserve.
Key Developments:
The Federal Reserve has raised interest rates aggressively in recent months to combat inflation.
The US economy remains relatively strong, supporting the dollar.
Geopolitical uncertainty is also driving investors to seek safe-haven assets, such as the US dollar.
Market Impact:
A strengthening US dollar is putting pressure on other currencies, including the Euro.
A strong dollar is also making US exports more expensive, potentially weighing on global trade.
Conclusion
Upward Support for the Euro
The Euro could come under upward support in the next five weeks if the French legislative elections result in a clear victory for President Macron's centrist coalition. This would ease political uncertainty in France and boost confidence in the Eurozone. A moderation in inflation and stronger-than-expected economic growth could also support the single currency. The release of the Eurozone's flash HICP inflation estimate for June on June 28 will be a pivotal event in determining whether the Euro's outlook improves.
Indifference for the Euro
The Euro could trade sideways in the next five weeks if the French legislative elections result in a hung parliament. This would prolong political uncertainty in France and keep investors on the sidelines. A mixed economic picture, with moderate inflation but subdued growth, could also contribute to a range-bound Euro. The outcome of the French elections on July 7 will be crucial in determining whether the Euro breaks out of its recent range.
Downside Pressure for the Euro
The Euro could come under downside pressure in the next five weeks if the French legislative elections result in a victory for the left-wing alliance or the far-right National Rally. This would increase political uncertainty in France and weigh on confidence in the Eurozone. A resurgence in inflation or weaker-than-expected economic growth could also put pressure on the single currency. The release of the Eurozone's second-quarter GDP growth estimate on July 30 will be a key event in determining whether the Euro's outlook deteriorates.
References
European Central Bank (ECB): https://www.ecb.europa.eu/
Eurostat: https://ec.europa.eu/eurostat/
Trading Economics: https://tradingeconomics.com/
Reuters: https://www.reuters.com/
Bloomberg: https://www.bloomberg.com/
Financial Times: https://www.ft.com/