Thursday 8 December 2016

Migrants in and British out weigh on state of euro

Lucy Meakin

Published 06/03/2016 | 02:30

Border guards erecting a fence in Slovenia late last year. European leaders meet next week to discuss the migrant crisis Photo: Reuters
Border guards erecting a fence in Slovenia late last year. European leaders meet next week to discuss the migrant crisis Photo: Reuters

It's not only European Central Bank stimulus that has the potential to hurt the euro.

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From the possibility that Britain might leave the European Union and the impact of refugees flooding the region, to concerns over the economic outlook and political turmoil in Ireland as well as Spain, the euro is facing a slew of hazards.

Set alongside economists' expectations for lower interest rates and more asset purchases from the ECB, investors are wondering how low it can go.

"There are monetary policy risks, there are political risks within the EU, there's the geopolitical risks from outside with migration, and underlying it all you've got a pretty lacklustre growth picture," said Frances Hudson, a strategist at Standard Life Investments.

"You could quite easily see a negative spiral developing."

The euro is the worst-performing major currency after the pound over the past month. While a falling currency may bolster the region's economy by stimulating exports, the recent declines reflect a troubled outlook for the bloc.

A Brexit would further damage trade and present unprecedented political challenges for the EU, while efforts to manage an influx of refugees by reducing free movement within the EU's passport-free Schengen area also threaten to hamper the transfer of goods.

Over 100,000 people have crossed the sea to Greece, Italy and Spain in the first two months of this year, after about a million made the journey in 2015. EU leaders meet on Monday to try for a solution.

"If you get a situation where people put the euro itself into question, then foreign holdings in European assets would become problematic," said Hans Redeker, a currency strategist at Morgan Stanley in London.

"One has to be very vigilant in the current environment and there's certainly a lot of pressure still building up."

Political turmoil is also on the rise, raising the spectre of weak governments and a move away from fiscal reform.

Uncertainty remains in Ireland after a vote which pointed to no clear winner, while Spain has been in deadlock for 10 weeks since its inconclusive election result.

Portugal last year endured weeks of wrangling before a socialist-led government took power.

Still, the euro has weathered many storms in its 17-year history, and so far the growing list of concerns hasn't knocked the currency out of the $1.05 to $1.15 range within which it has largely traded in the past year.

"The interesting point is why the euro isn't trading weaker," said Ewen Cameron Watt, chief investment strategist at BlackRock. "I suspect that's to do with the current account surplus in Europe -- therefore scarcity of euros."

Even so, the possible impact of suspending Schengen on the common currency is worrying Europe's political elite.

German Chancellor Angela Merkel told a March 2 rally in Rhineland-Palatinate that the strength of the euro "relies on the free movement of goods and services as well as people".

Supporting trade is particularly important in a bloc still struggling to recover from its recession and debt crisis, even as central bank bond purchases are pushing member-state's borrowing costs to record lows.

While quantitative easing is helping to insulate sovereign debt from the sell-offs seen in previous crises, it's leading investors to look to the currency to express their concern.

"Taking it all together we're negative on the euro," said Adam Cole, head of global foreign-exchange strategy at Royal Bank of Canada in London.

"We see it getting down to parity and trading around that level for a while."

Bloomberg

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