The story of the euro has been one of depreciation in the past year, with eurozone exporters apparently benefiting most from the decline in the currency.
After many months of uncertainty surrounding Greece earlier this year, it is clear the country will remain in the euro, for now. But while the Greek crisis has abated, emerging markets have been causing significant market volatility during the summer.
European Central Bank (ECB) president Mario Draghi has signalled his intention to continue with the bank’s asset-purchase programme to September 2016, and even beyond if required.
In a note published by the International Monetary Fund (IMF) in September ahead of the G20 meeting of finance ministers and central bank governors, the organisation pointed out preliminary data suggests the weaker euro has been a boon for exports in France and Germany in particular.
The IMF says: “In the euro area, the ECB’s expanded asset-purchase programme has improved confidence and financial conditions, and raised inflation expectations initially. More recently, however, inflation expectations have reversed and the euro has strengthened, which could put downward pressure on prices.
“Hence the programme should be extended if there is not sufficient improvement in inflation consistent with meeting medium-term, price-stability objectives.”
Alan Wilde, head of fixed income and currency at Baring Asset Management, says: “All things considered, the euro has held up well against the US dollar and the Japanese yen, but has weakened versus sterling. Considering the sharp reversal in bond yields in the second quarter, the protracted uncertainty of Greek bailout talks and the imminence of the first US [interest] rate hike, the euro could easily be much lower.”
So what does all this mean for investors exposed to the European currency?
Mr Wilde continues: “I believe the US dollar is set to gain further against all other currencies, so I would expect a lower euro in due course. A September hike by the Federal Open Market Committee [FOMC] will probably test this year’s lows… but conciliatory language that points to a shallow path of further increases may ameliorate the downside.
“Sterling should also strengthen versus the euro as UK growth is better and the Bank of England is likely to begin tightening not long after the FOMC.”
IG Group market analyst Chris Beauchamp agrees the euro has been “clawing its way higher” against the dollar.
He explains: “It has not been a smooth path, and the overall gain is slight compared with the hefty downward move last year. But predictions of the euro’s demise have been rather wide of the mark.
“While the ECB continues to hint at more quantitative easing (QE), it has stopped short of any explicit indication that more is on its way, and thus the main focus is US dollar strength.”
He adds: “It has been a similar story against sterling – a downward move to the end of 2014, then consolidation as QE gets under way and now a bounce as expectations of Bank of England tightening are pared back.”
But the euro remains susceptible to ECB announcements. Following Mr Draghi’s press conference on September 3, the currency fell 1 per cent to trade at $1.11 as he revised down GDP growth for 2015 to 1.4 per cent from 1.5 per cent and gave a stronger indication that more QE is a viable option.
Recent action taken by the People’s Bank of China to devalue its currency, the renminbi, sparked volatility in the markets. Roger Hallam, chief investment officer for currency management at JPMorgan Asset Management, thinks there is a chance this could weigh on the value of the euro this year.
“Chinese authorities have been intervening in foreign exchange markets to stabilise the value of the renminbi versus the US dollar,” he says.
“At some point, they will probably need to rebalance their reserve allocation, which will require selling euros and buying US dollars – an activity that will be net euro negative. We have yet to see that impact in the markets but expect it at some point this year.”
And Mr Hallam warns there are other factors that could come into play causing the euro some turbulence later this year.
He points out: “From a political standpoint, the euro is still somewhat vulnerable to bad headlines. Not in the near term, but as you roll forward towards the end of this year, you will need to watch out for any other political noise or difficult developments that would draw the markets’ attention to some of the structural challenges that the eurozone faces.”
Ellie Duncan is deputy features editor at Investment Adviser
Expert view
Chris Beauchamp, market analyst at online trading platform IG Group, considers the longer-term prospects for the euro:
“Both the euro/US dollar and euro/sterling trends have further to run as rate differentials finally appear in earnest, but a pause is the order of the day now.
Chinese volatility has so far not had too much of an impact on the euro, but the chief effect will come as more data comes in. If it suggests the Chinese developments have hit European growth, then this could well accelerate the euro’s descent, as European Central Bank QE2 [second round of quantitative easing] becomes more of a possibility.”
