EUR/USD: Downside Limited To 1.08 On Brexit's Political Contagion Risk

[thenews]

The political contagion from Brexit should become one of the major EUR drivers in coming months. While we do not expect any other in-orout EU referendums in the Eurozone, the upcoming political events – the Austrian presidential and German regional elections in September, the Italian referendum on the Senate reform in October and the general elections in the Netherlands, France and Germany next year – could trigger another bout of political uncertainty, especially if they indicate falling support for the mainstream, pro-EUR parties.

Growing political risk should negatively affect the real economy, the ECB outlook and EUR, even if the actual impact may be difficult to quantify. In particular, political uncertainty is likely to force businesses to delay investment and hiring, while consumers should postpone spending. This could add to the growth headwinds in the Eurozone and ultimately force the ECB to be more accommodative, making EUR an even more attractive funding currency in the process.

We doubt that the political contagion from Brexit will trigger another existential crisis for EUR, however. We note that the institutional set-up in many Eurozone countries makes it difficult to hold a referendum similar to the UK’s EU referendum. In addition, we believe that the ECB has the tools to fight and ultimately contain any fragmentation in Eurozone asset markets.

This, together with the fact that we do not expect the Governing Council to cut rates further into negative territory, would mean that the downside for EUR/USD on the back of growing political risks should be limited to 1.08 in our view.

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