Oliver Mangan: Euro falling out of favour as Ukraine crisis fuels currency volatility
Refugees wait in a crowd for transportation after fleeing from the Ukraine and arriving at the border crossing in Medyka, Poland, on Monday; the humanitarian crisis will impact financial markets. Picture: Markus Schreiber/AP
The last week has been particularly volatile in financial markets as they struggle to assess the implications for economies of the war in Ukraine, not to mention the major humanitarian crisis that is unfolding as each day passes.
It is clear that inflation will now rise even further in 2022, which has negative implications for growth in advanced economies, especially the EU.
Markets agree, with European stock markets under pressure in particular.
Meanwhile, there has been a scaling back of rate hike expectations in 2022 in all economies, though rates are still expected to be increased.
Bond markets have rallied on the back of the more benign rate outlook, as well as a flight to quality into safer asset classes.
Meanwhile, liquidity is poor in markets at present, making it difficult to execute trades and adding to volatility.
The eurozone economy is more exposed than others to the crisis, given its closer links with Russia, including its reliance on oil and gas imports from there.
Real household incomes and thus consumer spending, will be impacted by the further surge in inflation.
Uncertainty is an additional headwind for growth, especially as the conflict now seems likely to be drawn out.
However, there are offsetting factors including a looser policy stance, with a slower pace to monetary tightening, as well as a more expansionary fiscal policy from increased military expenditure and spending on the refugee crisis.
It is very difficult to quantify all the impacts, but some preliminary estimates from the ECB suggest that the crisis could reduce eurozone GDP growth this year by 0.3%-0.4%, though, it could prove to be greater.
It is not surprising that a major war in Europe has resulted in the euro coming under downward pressure.
Rate hikes are still imminent in the US and UK, but there are growing doubts about whether eurozone rates will be increased at all this year.
It is nearly six years, going back to the 2016 Brexit referendum, since the single currency has traded below 83p against sterling.
ECB monetary policy will have a crucial bearing on the currency, with this week’s governing council policy meeting an important event in this regard.
The ECB is likely to avoid giving any clear policy guidance in the current highly uncertain environment.
Nevertheless, the ECB will publish a new set of macro forecasts and there will be considerable interest in regard to its medium-term projections on inflation.
An end to the negative ECB interest rate regime next year is still expected. This would be positive for the single currency.
For now, though, the euro is very much out of favour on foreign exchange markets.
- Oliver Mangan is chief economist at AIB
