The start of 2015 provided an unfavourable backdrop for the EUR, with the single currency facing a triple threat from the ECB’s decision to embark upon a quantitative easing programme, Greek debt negotiations, and diverging economic trends with the US. More recently however, the EUR/USD has consolidated, with tensions over Greek debt negotiations subsiding and the emergence of a more constructive macroeconomic backdrop for the euro area.
While the Greek negotiations have dominated market headlines, there are nascent signs of a modest cyclical upswing in the euro area. A range of activity indicators have improved in recent months and are signalling a modest cyclical upswing in economic activity.
...Lastly, while inflation has been a key driver of the EUR/USD vis-à-vis its influence on market expectations for QE by the ECB, it is likely to take a back seat for the foreseeable future. Alongside positive (if slow) growth, the acceleration in the credit growth is not supportive of a persistent move into deflation. Headline inflation is likely to gradually recover later this year as the impact of lower oil prices dissipates.
While much of the weakness for the EUR/USD appears fully priced, a period of consolidation beckons in the near term. The cyclical recovery, while encouraging, remains fragile, and concerns over Greece are likely to continue to bubble away in the background.
Furthermore, the commencement of the ECB’s QE programme may provide additional headwinds to the single currency. If euro area banks sell euro area fixed income to the central banks and substitute those holdings with US Treasuries, then the euro in theory could weaken further, as that would likely imply an extension of the trends that prevailed late last year and in January of this year.
