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Euro strength seen as short-term as EU disunity continues

Today’s gains in the euro are seen as short-term, according to traders, after a major sell-off in yesterday’s trade. Against the Swiss franc, the euro fell to a record low of 1.1680.

Persistent eurozone debt fears remain, even after yesterday’s meeting of eurozone finance ministers and the subsequent resolution to avoid a Greek default at all costs appeared to stem the tide of negative euro sentiment. The euro rose as high as $1.4023 today after hitting a low of $1.3837 during the Asia session.

The reprieve looks temporary, however, strategists warn. “Essentially, the eurogroup offered nothing new yesterday,” Chris Walker, G10 strategist with UBS, tells EuromoneyFXNews. “It feels as if they're losing sight of the big picture. There was no mention of Italy or Spain, for instance. That shows you how focused they are on avoiding even a selective default for Greece.”

The bank maintains a three-month euro target of $1.3000, though Walker warns that the single currency could hit those levels within two months if a downward trend takes hold. “Against the Swiss franc, the euro could easily keep on going right down to €1.10,” he adds.

Contagion fears gathered pace yesterday with Italian government bond markets as the focus. Spreads between German and Italian government bonds widened, with the yield on 10-year Italian debt rising from less than 5% to hit 5.56%. Nonetheless, today’s Italian Treasury bill auction was oversubscribed, causing spreads with German debt to narrow again.

RBC Capital Markets senior currency strategist Elsa Lignos notes rumours of the European Central Bank buying Italian and Spanish debt in a strategy note. Reports do not specify whether the funds came from the European Securities Markets Programme or the ECB’s own funds, Lignos notes. “Either way, it offered one more prop for beleaguered European government bonds,” she says.

According to Paul Robinson, head of FX strategy at Barclays Capital in London, a correction may be short term. He argues that Italian prime minister Silvio Berlusconi’s seeming difference of opinion with other European ministers is adding to the uncertainty. “Italy has high debt and weak growth, and has done for a long time,” he says. “But second to Greece, the focus is now on them.”

Whether the euro’s losses are directional is still difficult to determine, however, Robinson says. “This is an environment where technical trading is very difficult. Movements are very event-driven at the moment. But if the banking stress-test results later this week are good, then we could see the euro rebound, certainly against the Swiss franc.”

The latest round of banking stress test results – due on Friday (July 15) – is designed to test the core capital adequacy of European banks. Market expectations on their significance are mixed, however. The last set of results gave several Irish banks a clean bill of health before they defaulted.

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