The price of the Euro against the Dollar has fallen from $1.25 to $1.23 in the last few days, with analysts expecting the Euro to continue its devaluation. The US government’s campaign to promote a weak Dollar as a way of rebalancing their trade deficit, coupled with a large infrastructure project generating inflation, has resulted in an artificial boost over the last 14 months to both the Euro and the Pound off the back of this weakness.
The key point to note here is that it’s an artificial boost; this isn’t inherent strength from the Euro, it’s market opportunism. The latest decline in Euro value against the Dollar is a sign of its instabilities returning and while it might appear a small amount, it could be the sign of things to come.
Italian General Election:
Change is in the air for Italy, and with it a hung parliament. The country voted outside of its usual centrist leanings to nominate the eurosceptic Five Star Movement, who won 227 seats, the right-wing Northern League (in a centre-right coalition with parties including Berlusconi's Forza Italia), who won the most seats with 265, and the Democratic Party (the former party of power, now in a centre-left coalition), who came third with 122 seats (down 60).
Photos courtesy of Shutterstock. L to R: Matteo Salvini (Northern League), Luigi Di Maio (Five Star Movement), and former PM Matteo Renzi (Democratic Party)
The populist changes are a threat to the Euro’s stability as both the leading parties have been vocal in their opposition to the single currency. The statistics back up their opposition too: in terms of GDP, Italy is now poorer than when it joined the Euro in 1999. In fact, Italy’s economic performance has been beneath that of Greece for the past 20 years – despite Greece’s huge economic collapse in recent years.
These figures were reported in The Washington Post, who ran a feature about the threat of the far-right in the election and the rise of the right across Europe as dissatisfaction with world economics – including policies from the European Central Bank – continues.
“The idea of Europe was supposed to cure, or at least temper, nationalism, not cause it. But it won't work as long as they make it impossible for the center-left to offer up an alternative vision to the far-right other than doing what Brussels says in the most efficient way possible.”
The reference here is to the fact that the ECB is pro-austerity, whereas the new Italian ruling parties are anti-austerity. For the past few years the centre-left in Italy has had the job of putting a silver lining on austerity and its impacts upon the Italian people, but clearly the electorate has lost faith. In a similar vein to how the Labour Party in the UK grew in popularity during the UK’s General Election last year, the two leading parties in Italy said no to austerity and promised tax reforms and an increase of the minimum wage. The fear is that any change in monetary policy in Italy could see them defy the EU deficit rules, default on their large debts, and crash the Italian banking system – with knock on effects for the rest of Europe.
This quote from The Economist sums up the risk to the Euro from political change in Italy:
“The Eurosceptic turn in Italy is partly explained by the country’s dreadful economic stagnation, and high unemployment, especially among the young; the single currency makes for an obvious scapegoat. Italy’s banks are weak and its debt burdensome. It is badly placed to weather the next crisis, especially if the ECB fulfils its pledge to end bond-buying later this year. Italians have plumped for political rupture under relatively benign conditions. A financial shock from China or elsewhere* could do real political damage there.”
*Editor’s Note: The USA and their trade war, perhaps?
Greek bailout:
The situation in Greece is perhaps what the situation in Italy could be. Starting in late 2009, the Greek economy was exposed by the 2008 Great Recession. Debt had been undercounted by the government which led to a crisis in confidence. The Greek authorities then triggered social unrest by rapidly raising taxes and cutting domestic spending as part of emergency austerity, leading to widespread protesting and riots.
It has been a slow process but the Greek government is finally at a point where it is registering economic growth; 1.7% last year and a predicted 2.5% this year. This is good news, but Italy will be fearful of following in Greece’s footsteps and entering a decade-long period of even stricter austerity, and investors will be even more scared at the thought of a second major bailout in the Eurozone and the potential cost; to date, the figure is over €230 billion in terms of what Greece has received to pay off its debts and bolster its banking system. Given Italy’s GDP is weaker than Greece it may take a larger figure to fix the Italian economy – money they won’t want to give over.
Trump’s trade war:
As hinted before, President Trump’s trade war inevitably gets a mention. It started as a dispute with China and South Korea over their cheap sale of solar panels and washing machines, in response to which the US installed a tariff against such products. This had the aim of protecting American businesses and putting them first but was soon followed up by a global tariff from the US on importing steel (25%) and aluminium (10%).
This hurts south-east Asia, but also Europe, to which the European Commission responded saying they were ready to impose safeguards, tariffs or quotas to prevent a surge of metal coming in to the continent in the absence of America buying. The EU also warned the US, stating that countermeasures may be taken against American exports, to which President Trump reportedly threatened retaliatory taxes against the European automotive industry.
The European Central Bank in Frankfurt, Germany
Eurozone growth:
This threat of diminished exports from the Eurozone leads us nicely onto the final risk to the Euro’s value: the growth of the Eurozone. Growth is the ultimate goal of the European Central Bank, but it can’t grow without increased exports, and even prior to Trump’s tariffs figures from Germany pointed to a decline in export growth – something with the bank needs to tackle.
To keep growth going the ECB is increasing its bond-buying strategy as part of its stimulus plan. Quantitative Easing has been acting like stabilisers for economies across Europe in recent years and Brussels is wary of withdrawing its support entirely, despite the global economic growth figures. It was reported that this support would be withdrawn early in 2018, so all eyes are on the ECB’s next meeting on Monday March 19.
One of the odd side effects of the stimulus plan is a weaker Euro. As CNBC reports, the fact the Eurozone needs help suggests the Euro isn’t a strong investment, whereas without it the currency looks a lot more attractive to investors. The problem for the ECB is that while they are happy to have a stronger Euro for investment purposes, it’s a balancing act between a strong and weak Euro in terms of the impact it could have on prices across the region and the cost of exporting. A higher valued Euro would likely lead to even less exports, which could undo all the work that the Central Bank has done with QE to get growth started again, whereas continued support could boost the Eurozone at the expense of the Euro.
