CHART OF THE WEEK
The most significant shift in the markets this summer was the sustained rise in the EUR. The single currency broke through 1.20 USD whereas in March 2017 it was trading at around 1.07. Having kept within a 1.05-1.15 USD range for two years, in mid-July the EUR broke through this ceiling and is currently trading at highs not seen since the end of 2014. The markets took Mario Draghi’s silence over the currency’s strength during his speech at Jackson Hole on August 25th as a carte blanche to drive the currency higher. Over the following four days, the EUR rose from 1.18 to 1.20 USD on August 29th.
OUR ANALYSIS
In the long term, the EUR should rise further as it is still below its purchasing power parity of around 1.30. In addition, the euro zone’s economic backdrop is improving enough to suggest rate hikes, though some way off, and still running a significant current account surplus.
In the short term, exchange rates could also be affected by other factors such as different monetary policies. In recent months, a pull-back in potential measures to boost the US economy and significant upward revisions to euro zone growth forecasts have led investors to buy the EUR. Nonetheless, the interest rate differential cannot fully justify a shift of this magnitude and a USD rebound in the weeks ahead is possible if inflation gains momentum after its springtime lull. This would be a likely scenario given the tight US labour market.
This should be of little consequence for the European economy as the recovery is essentially domestic and currency impacts on exports should be limited by the ongoing global recovery.
The opinion expressed above is dated 29 August 2017, and is liable to change
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