A bearish case for the euro and Europe ahead of winter
The global energy crisis negatively impacts the world’s economies and population, but Europe looks the most vulnerable. Ahead of winter, Europeans face a harsh reality of rising inflation, diving consumer confidence, and surging natural gas prices.
Add to it the war in Eastern Europe, and the perfect storm is coming.
The energy crisis and its implications for European economies
Russia invaded Ukraine six months ago, and the war continues. Europeans come from holidays only to discover that the energy crisis triggered by the dependency on Russian natural gas will have a profound economic impact.
Regarding natural gas prices, the German 1-year electricity forward traded above EUR800 per MWh for the first time yesterday. The implications of surging prices for natural gas are huge.
For instance, most European households were protected by governments from the surge in energy prices. But businesses remain vulnerable.
Europe’s energy-intensive industries are at threat of closure this winter. High electricity and natural gas prices deeply affect industries such as aluminum or chicken farming.
Let me give a simple example.
A local bakery in Germany must pay its energy bills that keep rising. Consequently, higher costs are passed to consumers via price increases.
Hence, rising inflation is mainly triggered by the energy crisis.
In turn, consumer confidence drops. When consumers are not confident, they reduce spending, thus triggering an economic recession.
This is the harsh reality facing Europe, and the European Central Bank (ECB) can’t do much about offsetting the negative impact of rising energy prices. It did lift the key interest rates from historic lows, but the decision had little or no effect on the common currency.
For example, the EUR/USD exchange rate is back at its yearly lows and falling.
EUR/USD trades in a bearish trend
A couple of hours before Federal Reserve Chair Jerome Powell’s speech at the Jackson Hole Symposium, ECB sources hinted at a 75bp rate hike next. The euro reacted and bounced across the board, but the rally proved short-lived as traders sent the EUR/USD exchange rate back below parity.
In summary, the ECB is in a challenging position to hike rates into an upcoming economic recession. Moreover, with Russia having no plans of ending the war and given Europe’s dependency on Russian gas, the energy crisis will not end anytime soon.
Therefore, the pressure on Europe’s economies and the common currency will only increase as we get closer to the winter season.
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