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Analysis-Major rate hike won’t save euro as energy shock deepens According to Reuters


© Reuters. The Euro banknote seen in this illustration was taken on July 17, 2022. REUTERS/Dado Ruvic/Illustration

By Tommy Wilkes and Dhara Ranasinghe

LONDON (Reuters) – The euro zone economy and its currency have suffered so severely from the deepening energy crisis that more aggressive monetary tightening from the European Central Bank will not can prevent a slide in the price of the euro.

The euro on Monday fell below $0.99 for the first time since late 2002 after Russia cut off supplies through its main pipeline to Europe, sending energy prices soaring and raising concerns about a potential recession. supply decline.

A weakening currency will be front and center for Thursday’s European Central Bank meeting as a weak euro – down 13% in 2022 – could worsen already record-high inflation through more expensive imports.

Weak euro adds to ECB inflation headache https://fingfx.thomsonreuters.com/gfx/mkt/myvmnzggdpr/euro2.PNG

Some policymakers have said the bank must be more concerned about the euro than it was during previous weakness, because gas is priced in dollars and a weak euro amplifies the impact of spending. rising energy costs.

Money markets value an 80% chance of the prime rate rising to 75 points this week, but analysts say that will do little for the currency.

“This big rate hike will do nothing to rescue the euro. A recession is ahead and geopolitical concerns are unlikely,” said Agnès Belaisch, strategist at the Barings Investment Institute. control”. “In fact, rising interest rates coincide with inflation and a recession in 2023.”

Goldman Sachs (NYSE:) on Monday forecast the euro will weaken to $0.97 and stay there for the next six months as the destruction of demand, caused by the gas crisis, will lead to “the contraction is deeper and longer.”

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

The euro has been negatively correlated with gas prices for months, meaning it tends to fall as energy prices rise. Gasoline prices have increased by 255% in 2022 and on Monday increased by 30%.

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The euro area is almost certainly entering a recession, with business activity falling for a second month in August.

The energy shock is causing profound damage, while the data shows speculators have placed their bets on the currency.

Euro short positions being built https://fingfx.thomsonreuters.com/gfx/mkt/xmvjoallapr/euro1.PNG

UniCredit estimates that in the five years before the COVID-19 pandemic, the EU imported about 400 billion euros worth of oil and gas a year.

If oil prices hold at $100 per barrel, euro parity, and natural gas prices at 100 euros – five times the average over the past five years – costs will rise to 600 billion euros, equivalent to 6% of GDP, calculated by UniCredit Erik Nielsen.

Economists and currency analysts expect the economic pain to be even more severe than predicted just a few months ago.

Robin Brooks, chief economist at the Institute of International Finance, said on Twitter (NYSE:) on Monday. “This weekend we begin to make the final change: ‘we are headed for a deep recession.’ Euro will fall even more.”

Still, some say the ECB can at least stem the euro’s devaluation with major interest rate hikes in the coming months.

George Saravelos, global head of FX research at Deutsche Bank (ETR:).

INFLATION PAIN

The euro has suffered less against other currencies against the dollar and the pound has also not been pushed up by a rally on expectations of stronger appreciation.

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

SwissRe’s head of macro strategy Patrick Saner said the impact of a falling euro on inflation was also not as big as many people think. He cited official data showing that a 10% drop in the nominal effective exchange rate of the euro led to a 40-100 basis point increase in consumer price inflation a year later.

But as Saner notes, “even the current marginal effects are not quite ideal”.

Inflation is driven by energy prices, so European producer prices are skyrocketing.

Deutsche Bank’s Saravelos points out that the euro’s inflation-based real exchange rate is near record lows, but an index based on producer prices is near record highs.

That means the eurozone’s competitiveness is rapidly weakening – a condition of a trade shock that would further damage the economy.

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