The tenth anniversary of a remarkable event occurred recently. On the morning of 26 July 2012, the then ECB president Mario Draghi gave a speech in London. The Italian used an investment conference in the British metropolis to give a strong commitment to Europe in general and the single currency in particular. The European Central Bank would do whatever it took within its mandate to preserve the euro. “And believe me, it will be enough,” Draghi emphasised before around 200 industry representatives, politicians and investors. As he gave his presentation in English, the phrase “whatever it takes” in particular entered the history books. Draghi’s promise is regarded as a turning point in the euro debt crisis of the time and triggered a rapid U-turn on the currency market: within seven weeks, the euro had appreciated from about USD 1.21 to more than USD 1.31.
Ten years later, it seems the single currency is in need of another “Whatever it takes” moment. Shortly before the anniversary of the legendary speech, the euro slumped below parity (USD 1.00) for the first time since the end of 2002. It is one of those little ironies of history that Mario Draghi was not entirely uninvolved in the latest development either: on 21 July, the multiparty coalition led by the 74-year-old collapsed. The elections at the end of September threaten to drag the highly indebted country further to the right. It's hardly surprising that the markets are not particularly keen on this scenario. The political crisis led to the difference in yields on Italian government bonds widening sharply from those of German debt instruments. Lately the risk premium (spread) of the southern European country has passed 200 basis points again.
The latest downward movement of the EUR/USD rate is not only an expression of concerns about a new euro crisis, but also the result of the general strength of the dollar. In the last few months the greenback has profited, firstly, from its status as a “safe haven” – many investors will have steered towards it in light of extreme geopolitical tensions. Secondly, it is being assisted by monetary policy, with the Fed taking strong action against high inflation. In June and July it increased the base rate by 0.75% each time. Following this double strike, the Fed Funds Rate stands at a range of 2.25% to 2.50%. By contrast, the ECB has adopted a rather hesitant attitude. Only at its most recent meeting in July did its board – for the first time in more than a decade – turn the interest rate screw. The institution led by ECB president Christine Lagarde raised the base rate by half a percentage point to 0.50%. At the same time it launched a new bond purchase programme, which the ECB hopes will give some support to heavily indebted states experiencing turbulence on the bond market. In concrete terms, the “Transmission Protection Instrument” is intended to ensure that there is no excessive divergence in the financing costs of the individual euro states.
Following the plunge below parity and the latest Fed and ECB decisions, the EUR/USD currency pair has stabilised somewhat. Monetary policy remains the key to its further progress. Central banks on this as well as the other side of the Atlantic should be paying careful attention to how inflation and the economy are developing. Ultimately, after all, the aim is to manage the balancing act between fighting inflation and supporting the economy as well as possible. As regards the macro-economy, the eurozone has recently proved to be relatively robust. Despite the war in Ukraine and the gas crisis, economic output in the first two quarters of 2022 grew more strongly on the same period the previous year than it did in the USA (see graph). Compared with each of the previous quarters, the world's largest economy has actually shrunk twice in a row. This then triggered a discussion about whether the US was already in recession. The surprisingly strong labour market report for July – 528,000 new non-farm jobs were created – speaks against the negative scenario. The growth in jobs, which far exceeded expectations, even gave rise to renewed speculation about interest rate hikes. It’s quite possible that players on the FX markets are now waiting to see what gear the currency guardians are going to engage. In August both institutions are enjoying a summer break. While the next ECB session will be held on 8 September, the Fed will be getting together on 20 September for a two-day meeting.
Source: Reuters; as at: 08.08.2022 Past performance is not a reliable indicator of future performance.
Sources: Eurostat, Statista; as at: 08.08.2022 Past performance is not a reliable indicator of future performance.
