Greg Gibbs, Director at Amplifying Global FX Capital, notes that the EUR had been stubbornly strong this year, displaying some of the strength exhibited by the JPY in the first half of the year as investors feared that extreme policy easing measures by the BoJ and the ECB may be counterproductive by driving their financial sectors into contraction.
“The perception that these countries may be losing the battle to lift inflation and running out of room or ideas to ease monetary policy further was causing their currencies to strengthen, contributed to a vicious cycle of deteriorating inflation expectations and confidence in central bank policy.
The EUR may also have been perversely supported by Brexit risk aversion and increasing uncertainty over the prospects for some European banks, including Deutsche Bank, creating repatriation of overseas assets back to the Eurozone.
More recently some of this more intense risk aversion may have dissipated. The rise in global bond yields may be helping stabilize confidence in European bank shares. Brexit risk has become more clearly priced-in to the GBP and the outlook more mixed. Repatriation flows in support of EUR have shifted towards more fundamental pressures such as a competitiveness drag from a weaker GBP on the EUR.
There is also a shift from a vicious to a virtuous cycle in relation to the EUR and bond yields. As in Japan, higher global bond yields tends to make ECB monetary policy look more effective. It can more readily buy bonds when yields are rising, and tend to hold down real yields, improving inflation expectations. This may tend to reverse excessive strength in the EUR in the first half of the year.
Even if Japanese and European economic growth and inflation data start to improve, and there are fledgling signs that it will, we might expect their currencies to remain weak for some time during this phase. This may simply be a reflection of their negative rate policies doing what they were intended to do – weaken their exchange rates to help boost inflation.”