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All things considered, 2017 was a good year to be long EUR – by New Year’s Eve, the single currency was up by more than 4% against sterling, and nearly 15% against the dollar. Fears that a flurry of elections – in France, the Netherlands, Germany, and Austria – might undermine the Union by bringing the continent’s various populist parties to power turned out to have been overblown. More importantly, the Eurozone GDP growth hit 2.6% (YoY) in the third quarter: its strongest rate since 2011 and one which finally lent some credibility to hopes of a sustained recovery.
Nevertheless, commentary around euro exchange rates largely focused on the other side of whichever currency pair was being discussed. Figuring out why this should have been the case is hardly a three pipe problem. For almost the entire year, headlines were dominated by the UK’s Brexit negotiations (where discussion over the impact on the UK economy completely eclipsed any considerations of the effect on the rest of the EU) and a US president whose administration looked unstable at best and sometimes on the verge of collapse.
All of this leaves one with the niggling impression that, despite the euro’s bumper year, much of its appreciation has been more to do with other currencies’ weaknesses than with the prospects of the Eurozone itself. That is not to say that the market ignored factors like the ECB’s decision to slow QE by cutting its monthly bond purchases in half, and of course this lent the euro support. But with inflation hovering around 1.5%, the effective real interest rate is close to -2%. In an economy whose GDP is on a firm upward trajectory, if not yet overheating, this level of monetary stimulus does rather suggest that the most probable direction is up – for both the euro and its interest rate.
To date, ECB President Mario Draghi has maintained that negative rates will persist long after QE is discontinued. Businesses and investors who would be caught short by further euro strength should not be so sure.
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