Eurozone inching towards deflation

OUTLOOK – SEPTEMBER/OCTOBER 2014

Inching towards deflation

The euro continued to suffer in August, hampered by a deteriorating Eurozone economy that inched closer to deflation, with inflation falling to nearly a five-year low of 0.3%, fiendishly far from the European Central Bank (ECB)’s “healthy” 2% target. The euro was no match for a strong US dollar, but its decline against sterling was relatively muted, although sterling was still strong in relation to the single currency.

More cautious moves from the ECB

Eurozone growth data continued to disappoint in August, with both German and French economies showing a lack of growth. Germany, the Eurozone’s star player, also saw the worst Economic Sentiment data since 2012, further lowering confidence in the ability of the eighteen-nation bloc to pull itself out of its predicament.

The ECB announced further support for the Eurozone economy in the first week of September, dropping interest rates even further, from 0.15% to 0.05%, and decreasing the deposit rate for banks from -0.1% to -0.2%. It also took first steps towards QE, but stopped short of implementing a full scale programme to help inject capital into the economy in the same way as the US and UK central banks have done.

Whether these latest updates to policy will work remains to be seen, but we expect that small steps like these could bolster the Eurozone economy, at best. For the Eurozone to flourish, more still needs to be done, and in greater degree – such as the implementation of a QE programme. The task currently facing the ECB is not simply to earn confidence from investors, but also restore their trust in the strength of the Eurozone economy.

At the time of writing (10th September), mid-market rates were at €1/£0.7908 and €1/$1.3131

 

Forecasts

The euro is under pressure. Against the US dollar, which is in the ascendancy at this moment in time, it seems highly likely that we will see further euro weakness. This is what the forecasts detailed opposite are all showing. It is much more difficult to forecast the performance of euro against sterling due to worries of a ‘Yes’ vote for Scottish Independence. If this does happen, then we are journeying into the unknown when it comes to what happens next, both for sterling and a new Scottish currency.

If not for these worries, then the euro would be in decline against sterling, as it is fairly clear that the ECB will be very proactive in kick-starting the Eurozone economy, which will be detrimental to the euro. In fact, there have been reports that the ECB is keen to see significant euro depreciation as part of their recovery plan and it is much easier to weaken a currency than strengthen it. Overall, the longer term should see sterling strengthen, but it is very difficult to see the outcome in the short to medium-term.

 

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