The EUR/USD pair continues to retreat as doubts continue to grow over the European Central Bank’s (ECB) options to help the eurozone economy crawl out of the deflationary trap it is in. The strong figures posted by the U.S. economy have boosted the USD versus the EUR. The Federal Reserve’s decision to end its quantitative easing program this year signaled the possibility of higher rates being introduced in the U.S. next year.
The ECB has been forced to seek alternative measures to stimulate the euro bloc’s economy. Germany is the biggest opponent of using more traditional monetary policy tools such as sovereign bond-buying. Chancellor Angela Merkel is unflinching in her austerity stance. She told German lawmakers last month that her government will not commit to raising public spending to stimulate the eurozone economy despite forecasting lower growth this year and next.
European leaders understand the message sent by the ECB. Reform and orchestrated efforts are needed to avoid a deflationary trap. That being said, the actual changes needed will not be popular with voters, and still have a large margin of error in an uncertain global economy.
European Austerity Squabbles Persist
The German chancellor has not wavered in her negative view of borrowing to invest in a possible recovery. She chooses to concentrate in the positives of austerity in Europe, like the bailout debt payments from Ireland, Greece, and Portugal instead of entertaining the idea that stimulus might be the right call at this time.
Merkel criticized ECB President Mario Draghi when he suggested in a meeting of economists that fiscal stimulus needs to accompany current monetary policy to be more effective. Germany is not willing to go ahead with that approach though Merkel herself has admitted that the eurozone economy is fragile. Instead, she is looking to France and Italy to pass the necessary reforms to align with the region’s austerity program.
External forces affecting Europe can be split in two: macroeconomic and geopolitical. In the macroeconomic arena, proactive central banks are pressuring the ECB from both sides. The Bank of Japan released stimulus to avoid losing momentum, while the Fed is on track to raise rates next year after U.S. economic growth was boosted by a stimulus program that ended in October. Investors see those actions as logical and reward the economies driving it with the needed direction of flows. Japan is awarded a weaker yen with which to boost growth through exports and inflation, and the U.S. dollar rises as the economy and future rates make it attractive.
The Ukrainian Question
The geopolitical situation that has the deepest impact in Europe is the Russia-Ukraine turmoil. Given the proximity of the conflict, and the region’s dependence on Russian-supplied natural gas, Europe has been hesitant to escalate sanctions. The European Union’s member states were better prepared this time though by stockpiling gas reserves. The low price of oil due to oversupply and the high reserves in Europe have minimized the overall effect of the armed conflict between Ukraine and pro-Russian rebel forces.
Tomorrow, the eurozone’s preliminary gross domestic product figures will be announced. German business and policymakers have already cut their forecasts bracing for the worst. After a contraction in the first and second quarters, a third contraction would land Germany in a technical recession. The European Commission cut its forecast for European growth earlier this month. The E.C. expects the economy to grow 0.8% in 2014, 1.1% in 2015, and 1.7% in 2016. The lower numbers reflect lower growth expectations from France and Italy. By comparison, the E.U. expects Germany to grow 1.1% in 2015 instead of 2%.