Euro Still In The Crosshairs

Sometimes these updates write themselves, especially when we are seeing a currency collapse in the way that the euro is at the moment. EUR saw fresh multi-year lows against most G10 currencies yesterday as markets remained unwilling to hold the single currency in an atmosphere of a possible Greek exit from the eurozone, negative interest rates and a EUR1.1trn bond buying program from the European Central Bank.

euro is the definition of a falling knife at the moment. Some would say that it has come too far, too fast – I have sympathy with that feeling – however, there is little strength in an argument solely of “what goes up, must come down”. As traders, speculators and investors are told at times like this, “markets can remain irrational much longer than you can stay liquid.” Currencies tend not to move in straight lines and I do believe a retracement is certainly due. Those looking to fight the euro’s corner at the moment had better be wearing Kevlar gloves or prepared to lose a couple of fingers when the knife comes their way.

And so the obvious question is how far can the euro decline? In EUR/USD terms, markets are already talking about parity and while that involves euro weakness, it also contains a hefty deal of USD strength. We have seen in the past few days just how little of the ECB’s quantitative easing plan was priced into the single currency, so there is a very decent chance that the same can be said for USD strength as the Fed starts to normalize its monetary policy by tightening rates.

The correlation between EUR/USD and EUR/GBP is 0.6802 at the moment and therefore, should we see a fall to parity in EUR/USD – a 6.5% decline – then we could expect EUR/GBP to fall by something around 4.4% over a similar time frame. That would give a EUR/GBP price of 0.6773 or 1.4765 in GBP/EUR terms.

These are not exact calculations or predictions in any way, and correlations do break down as well so I would not hang any hats on them. They simply go to show just how far this euro decline could run.

One side effect of that move would also be a lower GBP/USD; it would also fall to 1.4765 given a euro would be worth exactly the same as a dollar.

Of course, while this news is great for holidaymakers, importers and the European economy, it is less than fortuitous for both the Bank of England and the Federal Reserve. While imports of Italian, Spanish, German and French goods have got cheaper overnight, the associated lower imported inflation means that monetary conditions in both the UK and US are tightening i.e. real interest rates are rising.

This move lessens the need for interest rate hikes as the currency’s strength has already done a lot of the work for you. Bank of England Governor Carney warned yesterday that he expected inflation to fall to around 0.0% in the coming months and stay there for much of the rest of the year. Yesterday’s GBP strength will not have helped that argument.

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Technical teams will start to consider Greece’s reform plans today, after eurozone ministers lost patience with the slow progress since the four month bailout extension was made in January. Let’s see how far they get.

We also have UK industrial and manufacturing production numbers at 09.30.