Insight & Analysis

Currency weakness weighs heavily on ECB

Published: Jul 2022

Corporates with significant exposure to the euro can expect further pain over the coming months with the single currency trading at its lowest level against the dollar since 2002.

Stacks of coins going down in size - decreating currency

According to Kyriba’s latest currency impact report, European companies reported US$1.8bn in FX-related losses during the first three months of this year. The collective negative impact reported by both North American and European companies was US$16.46bn, a 144% increase from the previous quarter.

While the figure for European corporate FX losses is not massively out of line with previous quarters, what is notable is the continued impact of the weaker euro with the single currency being among the top five most volatile currencies weighted by GDP for the fourth quarter in a row.

Unfortunately for corporates that get paid in euros, there is little likelihood of this situation improving any time soon. In fact, George Saravelos, Global Head of FX Research at Deutsche Bank says the deterioration in the energy situation in Europe (the German natural gas shortage, France’s EDF announcing further cutbacks to electricity production) increases the risk of EUR/USD breaking even lower.

“If both Europe and the US find themselves slip-sliding in to a (deeper) recession in Q3 while the Fed is still hiking rates, 0.95-0.97 levels could well be reached,” he says. “The two key catalysts to mark a turn in USD are a signal that the Fed is entering a protracted pause in its tightening cycle, and/or a clear peak in European energy tensions via an end to Ukraine hostilities.”

The downturn in China has also been bad news for the euro since China is one of the EU’s largest trading partners.

“If demand for EU goods and services from abroad cools, it hurts growth and this has been evident in the substantial shrinking of the region’s trade surplus,” observes Kenneth Broux, Head of Corporate Research, FX and Rates at Société Générale. “The drop in EUR/USD since mid-April dovetailed with the move higher in USD/CNY.”

BNP Paribas analysts recently pointed out that the dollar tends to do best in two states of the world – when recession fears pick up; and when downside growth risks look worse outside the US. Both these phenomena have occurred simultaneously, providing the dollar with broad-based support.

“In our view it is hard to find much positive to say about the single currency and we retain our view that EUR/USD should trade at parity this year,” says Dominic Bunning, Head of European FX Research at HSBC.

“The latest services purchasing managers’ indexes show a significant deterioration,” he adds. “It does not appear that the shift in demand away from goods towards activity such as travel and leisure is materialising. Indeed, signs of travel disruption across Europe may limit how much this sector can positively contribute through summer.”

Germany reported its first monthly trade deficit since 1991 this month. Export growth remains weak across Europe and high commodity prices are pushing up import costs.

The ECB finds itself in a tough position as the European economy is vulnerable and hasn’t had to deal with positive interest rates, let alone an aggressive tightening cycle, for many years acknowledges Oanda Senior Market Analyst Craig Erlam.

“I expect it to proceed with far more caution than other central banks, as we have already seen, but once underway we could see the euro supported as long as the tightening doesn’t tip the bloc into recession,” he says. “It is a fine balancing act.”

Despite the downward pressure on the euro, Brandt Portugal, Co-Head of Western Europe Corporate Sales & Solutions, Rates & FX at Citi says the bank has not seen corporates making any significant changes to their hedging policies.

“Clients are still evaluating policy changes to be made as we emerge from Covid and understand the implications of the Russia-Ukraine war,” he says. “Understanding inflation risks and evaluating hedging alternatives in light of interest rate differentials will be top of mind as they reshape hedge policy.”

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