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ING, Capital Economics, Citi: The further plunge of the euro is one way – the energy crisis is a ‘trap’ for the currency

By Eleftherias Kourtalis

Further devaluation of the euro is a sure “bet” according to analysts, as the jump in the price of natural gas and the worsening energy crisis in Europe, combined with the onset of recession, “trap” the common currency on a one-way path of weakness .

In fact, according to ING estimates, the euro remains undervalued by about 5% against the dollar. The risk premium of the currency pair can remain for several months as it happened in 2015 during the Greek debt crisis and in 2018 during the Italian political unrest.

In other words, as the Dutch bank explains in today’s report, while an improvement in the eurozone’s growth climate may cause an asymmetric upward reaction in the euro/dollar exchange rate, a prolonged short-term depreciation is certainly likely if natural gas prices remain high and the threat of supply shortages is significant.

PMI data on Tuesday confirmed market concerns about the toxic combination of high energy prices and slowing global demand, with further euro depreciation thus the key scenario.

“A dip to 0.9800 against the dollar is more likely in our view than a sustained rally above the par in the near term,” ING said. Based on these developments, the ECB will strengthen its “voice” on the weak euro, but the practical implications for the foreign exchange market will be quite small for now.

“It seems increasingly likely that the worsening economic woes of the eurozone will lead to a prolonged period of euro weakness,” notes the Capital Economics in a new report. The euro’s recovery since mid-July has proved short-lived, he points out. The perception after the July meeting that the Fed was moving toward rate cuts led to some respite, but a series of hawkish comments from FOMC members and continued strong US economic data quickly erased that narrative.

Meanwhile, as Capital Economics adds, the news in Europe continues to worsen. Inflation continues to run higher than forecast, while forward-looking indicators of economic activity, such as PMI surveys, point to the onset of recession. The ECB’s attempt at an aggressive turn has not worked, and its latest forecasts (from June) already look extremely bullish on both inflation and growth.

“The main driver for both the deterioration of the economic outlook and the weakening of the euro is fears about the supply of energy in Europe and the prospect of persistently higher energy prices and/or natural gas bills,” the house emphasizes. The sharp increases in the price of natural gas in Europe coincided with the weakening of the euro against the dollar at the start of the Russian invasion of Ukraine and over the summer.

Arguably the most worrying aspect of the energy price shock facing Europe is the risk of a permanent “hit” to the region’s competitive position, according to Capital Economics. While earlier in the year it was mainly the price of natural gas for next-month delivery that shot up, in recent months the price of natural gas for next-year delivery has also increased. Many factories have been locked down in some energy-intensive industries and more may follow, the house warns.

ING, Capital Economics, Citi: The further plunge of the euro is one way -

At this point, the main – perhaps the only – argument in favor of the euro is that much of the bad news has already been priced into the exchange rate. But given that the shock to eurozone countries’ trade balances is starting to become permanent, and that high inflation is likely to prove more persistent in Europe than in the US – both imply a weaker euro to offset the deterioration in competitiveness of the eurozone – risks to the euro will rise further, Capital Economics concludes.

In his statements to CNBC, its strategic analyst CitigroupLuis Costa, also predicted that the euro would fall well below absolute parity with the dollar due to the energy shock in Europe.

As he pointed out, the rising prices of natural gas and other commodities are having a huge impact on European economies, which are already facing energy shortages in the aftermath of the war in Ukraine. That means the common currency is likely to continue to weaken against the dollar, he noted.

“Households in Europe are experiencing a much more violent shock, at least for now, than households in the US. That’s the story – that’s what brought the euro below par with the dollar,” Costa added, stressing that Citi is positioned to further depreciate the euro.

Source: Capital

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