The euro, which dropped closer to parity with the US dollar on Wednesday, is “unbuyable” as the shared currency struggles with Europe’s reliance on Russian energy and the European Central Bank’s overreaction to a jump in regional bond yields, Societe Generale said Wednesday.
The note from Kit Juckes, SocGen’s chief global currency strategist, arrived on the same day the euro dropped as much as 1% against the greenback to $1.0163, losing grip of $1.02 for the first time since November 2002.
“Europe’s energy dependency on Russia is falling, but not fast enough to avoid recession if the pipeline is closed. If that happens, EUR/USD will likely lose another 10% or so,” he wrote.
The pipeline in focus is Russia’s Nord Stream 1 that runs natural gas to Europe. Gas flows are scheduled to be halted from July 11 to 21 as the pipeline undergoes maintenance, but worries have cropped up that Russia will extended the time of the gas stoppage. Goldman Sachs analysts had expected a full restoration of gas deliveries after the maintenance but this week they said they no longer see that as the most probable scenario.
Russia has already cut down gas flows into Europe in response to sanctions put upon Moscow after its invasion of Ukraine in late February. Investors have been pricing in recession risks for the euro-area stemming in part from the potential of gas rationing. Germany, Europe’s largest economy, gets 35% of its natural gas from Russia. European Union leaders have pledged to reduce the bloc’s usage of Russian gas by two-thirds by the end of this year.
ECB’s ‘damaged credibility’
“Take away the gas risk and the euro would be a lot stronger, but we can’t do that, any more than we can take away concerns about the ECB’s anti-fragmentation policy,” said Juckes. The European Central Bank, led by President Christine Legarde, last month said it would prepare a tool aimed at tamping down a surge in eurozone bond yields.
European bonds yields climbed in anticipation of the ECB raising interest rates to combat high inflation. The ECB held an emergency meeting in June after Italian borrowing costs soared, reviving memories of eurozone crisis in the early 2010s.
The spread between Italian and German bonds has since narrowed and Italy’s 10-year BTP yield is well off a recent peak above 4% “but the damage is done,” said Juckes.
“The euro-supportive power of rate hikes is eroded by the fact that the bond market isn’t trusted to stand on its own two feet, and the ECB’s credibility is damaged by having over-reacted to a spike yields and spreads that was nothing more than a normal response to higher US yields and wider credit spreads globally. The euro loses out, remains effectively unbuyable this summer,” he said.
Juckes said the euro is so unbuyable that’s its been unable to drive higher against the British pound while that country undergoes a political crisis.
He also said the pound was unbuyable. Prime Minister Boris Johnson on Wednesday said he would hold onto his position following a wave of resignations this week from his administration, including those of Chancellor Rishi Sunak and Health Secretary Sajid Javid. The resignations follow revelations that Johnson named Parliament member Chris Pincher as his deputy chief whip even as he was aware of previous sexual misconduct allegations against Pincher.
The euro was off 0.8% against the pound on Wednesday. The pound was down 0.3% against the dollar.
See the latest EUR-USD movements here.