s-the-tide-turning-for-the-eurozone

Is The Tide Turning For The Eurozone?

Since the financial crisis of 2008, the Eurozone economy has struggled. In recent times, the European project as a whole has been throw into doubt. Brexit and the rise of nationalism across Europe have heralded difficult times. But recent economic data suggests things could be changing for the Eurozone. So is the tide turning for the Eurozone?

European Central Bank

My trading approach is based on fundamental analysis. Therefore, central banks play a pivotal role in shaping my trading decisions.

So in relation to determining the strength of the euro, I’ve been watching the European Central Bank very closely.

First, let’s get some context. The challenge of ECB has been stimulating consistent economic growth across the eurozone. Growth has been unevenly distributed. Some economies, such as Greece, Spain and Portugal, have struggled with high levels of unemployment. Meanwhile, Germany has experienced sustained periods of high employment and growth.

These countries all have very different circumstances. And that’s why it has proven difficult for the ECB to execute an effective monetary policy direction to stimulate growth. The ECB have attempted to stimulate growth with historically low interest rates (0%) and a quantitative easing programme.

These tools are intended to increase the money supply to the Eurozone economy. Let’s explore these tools:

Interest Rates

So why is the ECB’s primary interest rate 0%? It’s simple – the ECB want to encourage private European banks to borrow and lend more capital. In other words, interest rates can be described as the cost of borrowing money.

Remember, low interest rates act to weaken a currency. This is because of the laws of supply and demand. As a Forex trader, it’s vital you understand this concept.

Quantitative Easing

Since March 2015, the ECB has bought at least €60 billion worth of bonds per month from private European banks. This is known as quantitative easing – a tool designed to inject cash into an economy.

You might be wondering how this works. The theory is pretty simple. By buying a large amount of bonds from private banks, the ECB  increases the price of those bonds. Again, this is due to the dynamics of supply and demand. As the price of these bonds increase, more capital becomes available in the private banking system. As a result, banking products – such as loans – become cheaper for businesses and consumers. With more capital in the economy, the rate of business investment and job creation increases. This will cause consumer prices to increase, meaning the ECB can reach its inflation target of 2%.

Have The Tools Worked?

Theory is one thing – reality is another. Since 2015, the ECB has faced criticism for the extent of their quantitative easing programme from the likes of Germany (see video below). Initially, there were questions about whether the programme was actually effective in tackling sluggish growth and deflation.

However, economic data from 2017 has started to show economic growth picking up across the Eurozone. At its most recent meeting, the ECB revised its annual growth forecast for 2017 and 2018 upwards by 0.1%.

But it’s not all good news. The ECB did also cut its forecast annual inflation rate for the next few years. So while its quantitative easing programme has helped to create jobs, this hasn’t yet had a noticeable impact on consumer prices. This hasn’t deterred the ECB from continuing with its programme. At its June meeting, the central bank confirmed that quantitative easing would continue for the foreseeable future.

I think it’s still too early to see if we’re entering a new cycle of growth for the Eurozone. Growth is fragile at best. And inflation is lower than the ECB anticipated. That’s why I’m cautious about interpreting recent economic data as a change in fortunes.

This thinking applies to the euro too. In my mind, rallies for the euro are likely to be due to weakness in other major currencies – such as the pound (Brexit) and dollar (Trump).

Brexit & The European Union

At the start of 2016, I stated that the real risk to the eurozone and euro was political events following Britain’s EU referendum.

I still stand by that view.

Firstly, we have Brexit negotiations. With the form of the next British government still unclear following a ‘Hung Parliament’ election result, the EU will start these negotiations with a stronger hand. Representatives from the EU will be keen to exploit the weakness of a Conservative minority government. These negotiations are something traders should watch closely.

The election of Emmanuel Macron as French President was also a much-needed shot in the arm for an anxious European Union. But depending on how Brexit negotiations progress in the coming months, we could see other EU nations ask for their own referendums. Remember, most major EU nations have elections before 2019.

I think it’s certain that anti-EU parties will be competitive in these elections. If any of these parties get into power, another EU referendum is likely. Should another nation opt to leave the European Union – it could be the end of the Eurozone.

This potential scenario would be a great opportunity to go short on the euro. It’s something many market analysts and pundits haven’t identified as a possibility. But just as with Brexit and Trump, traders should be prepared for the unexpected.

Is The Tide Turning For The Eurozone?

The answer: it’s too early to tell.  And I’m sceptical. Having said that, weakness in the pound and dollar could provide short-term trading opportunities on major euro pairs.

I hope you’ve found this article useful. If you have any questions, please leave them in the comments below. I’ll do my best to reply to as many as I can. Please also feel free to share this article with other traders.

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