In the last week, (ECB) decided to increase interest gaits by 1/2 percent. In addition to the fact that the rate hike itself was the first in about 11 years, the sharp rate hike of 0.5% was a surprise, as the market was about half and half, even though there were reports in advance.
Nevertheless, the euro/dollar pair surged to the upper $ 1.02 level shortly afterward and then fell back to the $ 1.01 level. The top price is still heavy. Weak economic indicators continue in the US, and the dollar is weakening due to concerns about a recession in the US, so it seems likely that the euro will rise even further in combination with the ECB's sharp rate hike, but why is the euro's topside so heavy?
The background is, first of all, the remarks of ECB President Christine Lagarde. At a press conference after the board of directors, he said about future rate hikes, "it does not mean changing the final rate hike (terminal rate)." It was easy to speculate that the terminal rate would rise as the ECB decided to raise rates significantly by 0.5%. However, if the terminal rate does not change, if the rate is raised at a high pace, the end of the rate hike will be earlier. It is believed that this word has set back the further appreciation of interest rates in the euro area and led to a decline in German long-term interest rates.
The unique economic situation in the euro area seems to make ECB monetary policy difficult. The Eurozone Consumer Price Index (HICP) rose 8.6% year on year in June, a new record high. However, unlike the demand-pull type due to "overheating" as seen in the United States, this is a cost-push type of inflation against the backdrop of rising food and energy prices due to the Ukraine crisis. Cost-push inflation in the midst of uncertain economic pace seems to be similar to Japan, and like the Bank of Japan, he explained that "the rise in energy prices is temporary.
However, in the euro area, unlike Japan, the HICP has recently risen 3.7% in the core index excluding food/energy, alcohol, and tobacco, which is already well above 2.0%. In addition, because of the strong labor unions in Europe, accelerated inflation is likely to lead to demand for wage increases, and if left unchecked, there is a risk that wage increases will be repeated without a recovery in the real economy.
Furthermore, what is decisively different from Japan is that people's inflation expectations (expected inflation rate) tend to rise as inflation accelerates. If this spreads last-minute demand, it could further accelerate inflation. In fact, the expected inflation rate of the market (10-year breakeven inflation rate) soared at the end of April this year, and in some cases, it temporarily exceeded 3.0%. After that, the ECB suddenly turned to hawks, and the expected inflation rate fell to around 2.0%, but given the risk of rising again, the ECB cannot break its hawkish stance.
Due to these circumstances peculiar to the euro area, the ECB is in an extremely difficult situation where it cannot be as hawkish as the US Federal Reserve (FRB) and not as dovish as the Bank of Japan. On the flip side, if you raise interest rates aggressively, the risk of overkilling the economy will increase and the euro will depreciate. It is difficult to expect a rise in the price.
Second, lower confidence in the ECB may have partially affected the depreciation of the euro. At its July board meeting, the ECB completely ignored the "0.25% rate hike" notice (forward guidance) stated in the statement. As mentioned above, given that the ECB is under pressure to steer extremely difficult, there are some unavoidable aspects. In the future, he will stop presenting forward guidance and will make monetary policy decisions on a board-by-board basis "depending on the data."
However, market participants have experienced similar "ladder removal" by the ECB. For example, it is fresh in my memory that the schedule of the Asset Purchase Program (APP) specified in the statement in January this year was changed in March and the end time was advanced. Confidence in the ECB's forward guidance would inadvertently increase market volatility if the policy outlook was woven into the market and suddenly "withdrawn". If investors say "the ECB's communication is unreliable," it will be difficult for investors to take the euro-buying position with confidence.
Third, there are many negative factors for the euro area in the first place. Due to the high dependence of Russian energy on Italy, the Ukrainian crisis has caused the country's yields to rise. With the addition of the ECB's shift to hawks, Italy's 10-year bond yield temporarily exceeded 4.0% in June. Yields, which had once fallen due to the ECB's emergency board meeting and the policy of curbing market fragmentation, are rising again due to the political turmoil seen in the resignation of Prime Minister Draghi. If the populist government is born in the autumn general election, there is a widespread belief that fiscal consolidation will be delayed, and the yield gap between Germany and Italy may widen further. In this case, the euro could be further marketed, as was the case in 2011 during the European debt crisis.
The EPU global index soared to 430 in March 2008, when there was a corona shock, and then regained calm as the corona converged, but rose again due to the tightening situation in Ukraine in February this year. Currently, it is around 300. The graph of EPU after 20 years has almost the same shape as this global index in all countries including the United States and Japan, but it is China that has risen sharply this year, which is different from these. Surprisingly Germany. Germany's EPU soared to 785 at the end of March this year. Although it has declined since then, it was 585 as of the end of June, which is still higher than the corona shock of 498 in March 2008.
Interestingly, Germany's EPU is linked to changes in natural gas prices (TTFs), and the effects of sanctions on Russia appear to be overshadowed. In July, the supply of natural gas from Russia to Germany through the "Nord Stream" was suspended and then resumed, but the supply is reportedly reduced by 80% from July 27. If the cost of additional procurement of natural gas is passed on to the price and the use of household heating increases in winter, there is a risk that inflation in Germany will further increase.
The euro is likely to fall again against the dollar amid continued uncertainties in the euro area. There is a possibility that the parity (equivalent) will be interrupted again. However, given that the yen will continue to depreciate, for the time being, it is unlikely that the euro will fall sharply against the yen. Due to the rise of the dollar/yen and the depreciation of the euro/dollar, the euro-yen may be almost flat at around 140 yen toward the end of the year or maybe heading toward a slight appreciation of the euro.
* Maki Ogawa is an executive officer and general manager of the Financial Markets Research Department of Sony Financial Group. After working as an exchange dealer at a US financial institution, he engaged in exchange hedging and market research at Sony's finance department. After that, he was in charge of research and analysis of financial markets and information provision for individual investors as the director of the investment research planning department of the personal finance department at Citibank Japan (currently SMBC Trust Bank).
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