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The euro finds strength, but can it last?

The initial shock of the pandemic has subsided and the EU has approved historic levels of budgetary support to member states, contributing to a recent surge in value for the euro. But is the outlook for the currency as rosy as current sentiment suggests?

Pandemic compounded already challenging economic conditions in the EU

The euro was facing headwinds even before the pandemic, as Germany’s flatlining growth was already pushing it towards a possible recession.

When the pandemic hit, the lockdowns imposed across Europe and the wider world then created tremendous economic fallout. Steep falls were seen in GDP, particularly in Q2, as government reactions to the pandemic kicked in. In that quarter, the Eurozone saw the largest fall in GDP in 25 years, as its GDP fell 12.1% indicating a deeper-than-expected depression and a long road to recovery

The currency rallies

Recently, we have seen the euro strengthen, most notably against the US dollar2. For example, the euro was worth US$1.1933 on August 18. It has since fallen back to a 1.1800 handle.

Much of this growth has happened on the back of the €750 billion EU Recovery Fund being signed off, €390 billion of which is being distributed as grants rather than loans. Jake Trask, Senior Manager, OFX London, said: “ It is significant that it included grants and not loans. Throughout the Greek debt crisis, EU nations only offered loans in its efforts to bailout its beleaguered Southern members.

As well as the agreement over the recovery fund by EU leaders, most major economies are showing a recovery in both services and manufacturing after the huge falls seen in April as the effects of lockdown rocked all corners of the EU.

Source: OFX historical rates

A strong euro is good news for US dollar buyers

This strengthening of the euro is good news for anyone who is buying goods or services from US companies, or anyone trading with sellers who want to be paid in US dollars – something usually common in China and the Middle East. This makes those goods relatively cheaper.

However, talk of the US dollar’s demise as the leading safe-haven currency3 after its fall of around 9% since March this year is likely to be short lived, said Mr Trask. He feels there are a number of factors – including the poor US response to COVID-19, the EU having relatively more positive news on COVID-19 than the US and the US Presidential election which typically reduces the value of the US dollar – playing their part in its current weakness.

He added: “Flows out of the US dollar are likely one of the main drivers for the euro’s rally of late so the rise of the euro against the US dollar is likely to be a bit overdone.”

Brexit woes

Another major threat to the value of the euro is Brexit. A UK/EU trade deal would remove uncertainty and while it would benefit the euro marginally, the pound would rise more significantly. But it isn’t yet on the cards.

Mr Trask said: “This removal of uncertainty will benefit the euro but not to the extent it will sterling, which will likely soar should an agreement be struck. But a no-deal Brexit would make it hard for the euro against the US dollar.”

By October, we should have a clear idea about whether a deal is likely or not. For now, while the euro may look like a safe haven currently, it is unlikely to retain this status, with the US dollar “always a place to park your cash in times of extreme crisis” said Mr Trask.

1https://www.ft.com/content/c45cf867-2821-4d3a-ab48-0bc809f8cf26
2https://www.nytimes.com/2020/07/31/business/europe-economy-recovery-coronavirus.html
3https://www.smh.com.au/business/markets/is-the-us-dollar-losing-its-clout-as-the-world-s-reserve-currency-20200729-p55gja.html

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