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Fed Taper Talk Cools Euro Rally; Reassurance for Eurozone Stocks By Investing.com

© Reuters.

By Geoffrey Smith 

Investing.com — Just as things were beginning to look a bit ropy for Europe’s exporters, help may be at hand.

Only a couple of days ago, the was at its highest in nearly three years, having risen 12% against the dollar from its post-pandemic low. Many analysts had already assumed that $1.25 would be the next big number to fall, with an overshoot as far as $1.30 or even further seen as possible by some.

That threatened to derail a Eurozone economic recovery that, despite signs of more action from governments to support domestic demand, is still going to depend to a large extent on exports.

However, a spate of comments from the Federal Reserve in the last week has encouraged speculation that the U.S. central bank may entertain thoughts of winding down its stimulus as early as the end of this year.

At the same time, the prospect of a unified Democrat-controlled Congress has shifted expectations of U.S. bond issuance higher. The premium over the corresponding has widened by 12 basis points in the last week, improving the relative attractiveness of the dollar. As such, the euro is back at $1.2160 and looking less of a one-way bet.

An interview given by the European Central Bank’s Isabel Schnabel to Austria’s Der Standard, published on Tuesday, helps to show why, pre-empting a discussion that is almost certain to figure prominently in the euro zone over the coming months, namely, the rebound in headline consumer prices that will push all kinds of buttons among the region’s inflation hawks.

A rise is as good as pre-programmed, given that energy prices collapsed a year ago as the pandemic erupted, and given that a cut in value added tax in Germany, the Eurozone’s largest economy, which ran through most of last year, expired at the end of 2020.

A couple of upticks in measured prices, however, do not make a return of inflation.

“There are no indications that we need to be concerned about inflation being too high,” she said. “The main problem is probably that economic demand is too weak.”

Banks including JPMorgan and UBS have argued that the euro zone is likely to suffer a ‘double-dip’ recession around the turn of the year, with both 4Q 2020 and 1Q 2021 GDP numbers coming out negative due to extensive lockdown measures across the region.

Even if a faster-than-expected rollout of vaccines across Europe allows a quick recovery, Schnabel argued that the main point is still valid.

“The prices for services, such as travel or eating out, may soar on the back of the pent-up demand. But such a short-term development should not be mistaken for a sustained increase in inflation, which is likely to only emerge very slowly.”

In other words, the ECB doesn’t want you to even think about a weakening of its stimulus any time soon. The upward drag from Treasury yields may force it to spend a little more in keeping Eurozone yields anchored, but given that the ECB spent only 57 billion euros in December on its Pandemic Emergency Purchase Program and has the freedom to spend over another trillion in the next 15 months, that shouldn’t be too hard.

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