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Euro good luck streak ends as Eurozone data points to recession

The euro lost out against the pound and US dollar for the first time since mid-July this week, as faltering economic conditions point to recession in the eurozone.


Welcome to the Pure FX account of the latest changes in the euro exchange rate, covering the 14th to 21st September 2012. This is intended as a brief guide to movements in the euro this week, to put you in the best position when you exchange currencies.

Exchange rate changes

GBPEUR: 1.2415 to 1.2511 (+0.773%)
GBPUSD: 1.6198 to 1.6252 (+0.333%)
EURUSD: 1.3048 to 1.2987 (-0.468%)

So the euro’s run of good luck comes to an end!

The common currency lost out against the pound and US dollar for the first time since mid-July this week, as faltering economic conditions point to recession in the Eurozone, and Spain keeps the markets guessing about whether it intends to tap the European Central Bank’s bond buying scheme.

That proved enough to undo recent optimism following the ECB unveiling of its rescue plan a fortnight ago, as well as market jubilation as the Federal Reserve announced its third round of quantitative easing last week. Of course, if you plan to buy euros, this could suggest the tide is now turning in your favour.

What’s affected the euro this week

Concern that the Eurozone might soon enter official recession proved the euro’s undoing this week.

According to the latest Purchasing Managers’ Indices (PMIs), economic activity in Eurozone manufacturing and services fell to 46.0 this month, once again below the 50.0 point that separates expansion from contraction.

This is a situation the Eurozone has been in throughout 2012, although, until now, the continent has avoided the ignominy of entering official recession. It could be that that run of good luck has now come to an end.

Of special note, this month, economists had been hopeful that the European Central Bank’s announcement of its bond buying scheme would boost business confidence. It was after all designed to keep Spain and Italy in the euro, without losing access to financial markets.

Yet, as David Song, Currency Analyst at DailyFX comments “the debt crisis continues to drag on the real economy.” This suggests hopes that the ECB scheme might bolster confidence haven’t come to fruition.

Furthermore, it’s possible the situation in the Eurozone could deteriorate further. Chris Williamson, chief economist at Markit, notes that “That is a very downbeat assessment of where companies think the economy is going to go in the next 12 months.” This suggests that businesses expect conditions to remain just so into 2013.

Hence, all that proved too much for the euro rally, and the common currency succumbed to demand for safer havens this week, such as the pound and US dollar.

What’s going to affect the euro next

Since economic conditions in the Eurozone look set to remain tough, what happens to the euro next depends almost entirely on Spain, and whether the country gets its act together and requests European Central Bank aid.

As I said above, one of the reasons business confidence hasn’t improved on the continent is that, following the ECB announcement of its scheme two weeks ago, it was widely thought that Spain would take the first opportunity to accept it, to lower its exorbitant borrowing costs. Evidently however, that’s proved not to be the case.

Might this reflect a misreading of the situation on the part of the markets, rather than lethargy in Madrid? Undesecretary of Finance in Italy Gianfranco Polillo seems to think so. He said this week that “There won’t be any nation that voluntarily, with a preemptive move, even if rationally justified, would say – ‘I give up my national sovereignty.’”

This reflects the fact that, for Spain, it’s not a simple case of walking up to the front door of the ECB in Frankfurt with an empty money sack and saying, “Fill ‘er up.” Receiving central bank funding is conditional on Spain accepting a bailout, with all the stuff about welfare cuts, tax rises, and handing budgetary control to the IMF that implies.

It could be that, given that, Madrid is waiting until the last possible moment to request ECB aid, when its borrowing costs are beyond sustainable, and it has no choice but to accept help, and surrender sovereign control of its budget, or exit the common currency.

As Mr. Polillo puts it, the scheme will only “be activated only when the countries have the water up to their necks.”

Given that, what of the euro exchange rate? Well, for all Spain’s dallying, the markets believe it’s only a matter of time until funding conditions worsen for Madrid, and it’s left with little choice but to go cap in hand.

Jonathan Cavenagh, currency strategist at Westpac Banking Corp, said this week for instance “We’re getting much closer to a formal Spanish bailout and that kind of reduces some of the tail risk associated with the European outlook.”

What does he base this on? Nothing, so far as I know, except the fact that Spain is little more than a life raft right now, and every day the sharks are circling closer. Give it a month, six weeks, and I think Madrid will throw in the towel. And that could well support the euro.

Find out more: To find how what I’ve talked about here will affect your euro transfers, and receive a free quote, simply fill in your details into the form below. I’d be delighted to answer any questions you may have.

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Peter Lavelle is an economist at foreign exchange broker Pure FX. For a free no-obligation quote regarding changing currencies, get in touch at foreign exchange specialist Pure FX.

Copyright: Peter Lavelle, Pure FX
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