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The euro strength creates a headache for the European Central Bank (ECB), by tightening financial conditions amid weak growth and deflation. The rhetoric against the common currency strength may ramp up with further ECB easing likely, creating headwinds for additional euro strength, economists at HSBC inform.

Key quotes

“What strikes us is how divergent the EUR’s broad rally is vs. the economic backdrop in the Eurozone. We believe the Eurozone economy will find it incredibly hard to accommodate a strong currency for any sustained period of time. Therefore, the euro strength looks unsustainable. While the markets might be ignoring this for now, at some point, it will matter and the dissonance will be deafening.”

“In an economy deep in recession and facing deflationary pressures, the EUR’s strength is creating much tighter financial conditions than would otherwise be in place. The market may not care about this disconnect for now, but it creates a big headache for the ECB. Through analysing the raw text of ECB communication we see that the ECB is referring to financial conditions more than ever before.”

“In the current environment, where EUR strength is much less justified by the economic backdrop than it was in 2017-18, we believe the ECB’s rhetoric on FX is likely to ramp up with further easing likely. With markets preoccupied by the Fed’s policy framework shift to average inflation targeting, the risk of such a shift by the ECB has been completely ignored for now. As and when this happens, further strength in the EUR should be curtailed.”