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The following guest post is courtesy of Jasper Lawler, Senior Market Analyst at FCA regulated broker LCG.
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The euro has had a tough ride over the past 6 weeks. The common currency dived almost 7%, to a 10-month low of $1.1511 at the beginning of May, as Italian political jitters weighed on sentiment. More recently the common currency is better bid at $1.1750, boosted by comments from ECB chief economist Peter Praet that the central bank would begin discussing the winding down of the current QE programme.
Whilst the ECB has been saying for a while that it would use the summer to discuss plans on how to end the bond buying programme, questions have arisen over whether the ECB will be able to conclude the programme with so many risks still on the table.
Softer data continues to pour out of the eurozone. Even industrial production figures missed expectations, in what has become the new norm. Data is considerably weaker than it was in October last year when Draghi extended QE; GDP fell from 0.7% in Q4 to 0.4% in Q1. This softness has now been going on a little too long to be able to call it a soft patch. That said, the fact that the ECB are contemplating the end of QE indicates that they still believe it’s a temporary weakness.
Bucking that trend is inflation which is on the rise, jumping from 1.2% in April to 1.9% in May. This sharp rise has been mainly put down to higher oil prices with core inflation remaining subdued at 1.1%. However, inflation at 1.9% supports a move towards tightening policy.
Brewing trade war fears, which were highlighted at the most acrimonious G7 Summit in its history, have done little to boost the outlook for the bloc, with economic sentiment in Germany at its lowest level since 2012. Trade war fears could weigh on economic growth of the bloc going forwards.
Italy remains a problem. Whilst the new Italian finance minister sounding Europhile has gone some way to calming investors nerves, there are still key members of the new government who have made promises which will be difficult to fulfil whilst remaining in the parameters set by the eurozone. As result, it is too early to write off the Italian risk.
Normalisation is coming:
Despite these headwinds, the fact that ECB Chief Economic Praet (known dove) made those comments was a deliberate message to the markets that normalisation is coming and the doves in the ECB are fine about this. Money markets have completely priced in a rate hike by July 2019, with the probability of a hike by June 2019 up to 70% from 50%. The fact that ECB members are talking about policy normalisation, despite the strong headwinds suggests that the euro could be heading back to $1.25 sooner rather than later.
However, so far the euro’s reaction remains relatively muted which illustrates the concerns that investors have with weaker data, the political saga in Italy and trade war concerns running rife. Draghi will almost certainly want to keep his options open and taper the programme rather than looking for an abrupt end.
This is just the start of the discussion laying the ground work for the next step, the details are expected to come through in July. Should the ECB come through with a definite timeline to the end plan in June, then euro is likely to jump higher on the commitment targeting $1.184. However, realistically this is unlikely to happen, and Draghi & Co are expected to set the stage for a July announcement with a tapering into December most likely. This isn’t expected to spell any particular trouble for the euro as the outlook remains positive with the end in sight.