Euro's resurgence brings its own headaches
The notion that the euro could be a haven in times of turmoil seemed preposterous just a few weeks ago. Yet that's exactly what it's become as the world gets rocked by everything from devaluations to bear markets in stocks.
The euro has surged more than 4pc against a basket of peers in the past month, the biggest gain in the group. It's up against more of the world's major currencies than the dollar, yen, Swiss franc or pound. And it's climbing even as the European Central Bank (ECB) expands the supply of euro through quantitative easing (QE).
While the rally signals confidence in the single currency following the Greek crisis, it also complicates the ECB's efforts to jump-start the Eurozone economy. That's because a stronger exchange rate has the potential to curb exports and slow inflation. "Safe-haven flows have been mainly targeted at the euro, which I think is stunning," said Thu Lan Nguyen, a strategist in Frankfurt at Commerzbank. "The ECB won't just stand aside and may start to try to verbally weaken the currency. That's their prime instrument for delivering inflation."
China's shock devaluation this month sparked a rout in emerging markets that's prompted investors to unwind carry trades funded in euro. These deals involved borrowing at the ECB's near-zero interest rates to fund higher-yielding purchases, and cancelling them means buying euro back.
Growing scepticism that the US Federal Reserve will raise interest rates in September is also supporting Europe's single currency at the expense of the dollar.
"As the euro's been funding China carry trades, a position wind-up has seen it soar," said Neil Mellor, a foreign-exchange strategist at Bank of New York Mellon. "In the longer run, though, the strong-dollar view will prevail because of the divergent monetary policies."
The euro rose above $1.17 on Monday for the first time since January. It's up about 11pc from a 12-year low reached in March when the currency union seemed in danger of splintering and the ECB started its QE bond purchases. That wasn't in the playbook, either for ECB officials or most currency strategists.
Just three of 69 analysts predicted the euro would climb to its current levels by year-end back in March. While ECB President Mario Draghi has consistently denied using QE to target the exchange rate, he's acknowledged the economic benefits a weaker euro can bring through higher inflation.
The dwindling chance of an imminent move by the Fed is really what's driving the euro higher, rather than anything fundamental to Europe that would worry the ECB, according to Petr Krpata of ING.
"Euro-dollar strength is largely a function of a weaker dollar," said the London-based currency strategist. "Given that the ECB's QE is under way and the market already has a dovish view on the ECB, the euro is more immune to markets re-pricing the global inflation outlook." (Bloomberg)