The news coming out of the 18-member Eurozone is grim once again. There was a brief period in the second half of 2013, where it appeared that the region was finally starting to turn things around. Some economists had even forecast for steady strong recovery. That, however, never happened.
Instead, the Eurozone is once again staring into the abyss of another recession, a triple dip recession to be exact. So what went wrong?
Here at Future Currency Forecast we look at why the Eurozone is back in the spotlight for all the wrong reasons and the implications a recession will have upon the Euro (EUR) exchange rate.
The miserable headlines surrounding the Euro are familiar to any trader or economist who was in the business in 2012. Back then, we were in the thick of the Euro crisis, and Greece was on the verge of economic collapse. Recession was widespread amongst the Eurozone member nations, unemployment soared and growth was nonexistent…, sound familiar?
Things looked bad, but the situation was saved by European Central Bank (ECB) President Mario Draghi who came to the rescue by vowing that the bank would do whatever it took to save the Euro. His words worked and worries began to ease.
Some cynics accused Mario Draghi and European leaders of simply kicking the can down the road and not addressing the region’s and currency’s weaknesses.
As the global economy began to recover (led by the USA and Asia), the markets seemed to forget that unemployment remained staggeringly high and that growth in many nations save for Germany, was stagnating. To outsiders the market was ignoring the regions troubles, putting its faith in Draghi, and concentrating on the strength of Germany.
Geopolitical Tensions Affect the Euro
The lack of negative talk regarding the Euro by economists paid off and sentiment towards the single currency improved. For a time, it appeared that even struggling Eurozone members such as Spain were beginning to show signs of recovery. France and a few other Eurozone members were still struggling but optimism of a German led recovery dominated.
Then the situation in Ukraine deteriorated.
In February 2014, President Yanukovych fled Kiev and a new pro Europe government was installed. As the months passed, tensions mounted with Russia as Putin deployed troops to the eastern Ukrainian border.
In April, violence broke out as pro-Russian militants declared independence from Kiev. As the months progressed, the conflict deepened causing the European Union to impose sanction against Russia. A move, which would prove to have negative consequences on Germany, a nation that has close business ties with Russia.
Lack of Effective Action Impacts the Euro Exchange Rate
With Germany’s economy weakened, and inflation falling well below the ECB’s target of just under 2%, the central bank was forced to take action. On September 4, the bank cut interest rates to a new record low of 0.05% and announced a plan to spend up to €500 billion buying bonds and securities. As time passed, the measures had little impact on the declining inflation rate, which continues to fall. The conflict in Ukraine meanwhile continued to harm the German economy.
Draghi once again tried to reassure the markets but his frustration with the regions member states was evident. He clashed with German leaders on a plan to introduce quantitative easing and urged leaders to encourage more spending to encourage growth, something that goes against Germany’s policy of austerity.
This month, worries over the health of the Eurozone caused investors to grow increasingly concerned that the region is heading towards a triple-dip recession. With German manufacturing and exports falling dramatically, sentiment towards the Euro fell sharply.
With data report after data report continuing to be negative and with deflation and high unemployment, still a threat it is looking increasingly likely that Germany and the wider region is on course to slide into a triple dip recession. Economists are forecasting that the region could end up like Japan, and become stuck in a sustained cycle of stagnation.
The Impact on other Exchange Rates
The weakness of the Eurozone will not only have a negative impact upon the Euro and European economies but it will also have detrimental impacts on nations who rely on trade with the region. UK Chancellor George Osborne warned over the weekend that the weakness in the Eurozone is the greatest threat to the British economy.
While the USA and UK are, in the International Monetary Fund’s words, ‘approaching economic lift-off’, the Eurozone is back in intensive care.
Are there any solutions?
The Euro was flawed from the start. Establishing a single currency for eighteen separate and different countries was bound to cause issues. According to many economists including those at the ECB the only way to ensure the viability of the currency is for the nations of Europe to accelerate the process of fiscal union. A move that would likely result in German taxpayers paying for weaker members, something that would be deeply unpopular. With no agreement on the cards and the rise of anti-Euro political groups, that choice is increasingly difficult to implement.
Another suggestion could be to split the Eurozone in two and have one currency for the wealthier Eurozone members such as Germany, France etc… And another bloc for the smaller economies of Greece, Cyprus etc…
The final idea which would only be implemented if Euro sceptic parties ever took power would be to ditch the currency altogether and allow European countries to use their own currencies once more. With the rise of the National Front in France, Alternative for Germany and the UK’s UKIP this option could become a reality in the unlikelihood that they take power.
Euro Exchange Rate Forecast
In the short term, the Euro could find support from news that Russian President Vladimir Putin ordered his troops to withdraw from the Ukraine border. Investors remain cautious after the International Monetary Fund (IMF) cut its forecasts for global growth in 2014 and 2015 last week and warned that global growth may never reach its pre-crisis levels ever again.
With the Bank of England (BoE) and Federal Reserve contemplating raising interest rates their policies highlight the diverging trend with those of Europe and the policies of the European Central Bank.
In the long term, the single currency is likely to remain under pressure against its major peers such as the Pound (GBP) and US Dollar (USD). If economic data from the region continues to disappoint, investors will raise their bets for the region to slide back into recession, something that will weaken the Euro and see the exchange rate fall.
