Analysts say this week’s challenge to the European Central Bank from Germany’s constitutional court could dent the value of the euro.
The currency has lost around 1.4 per cent of its value against the dollar since the start of the week, slipping sharply immediately after the court threatened to block the central bank’s purchases of German bonds, in a move that could complicate the ECB’s efforts to tackle the Covid-19 crisis. The ruling rebuffed part of a 2018 judgment from the European Court of Justice.
On Wednesday, the euro hit a low of $1.0783, and some analysts predict the currency could sink to $1.02 by the end of the year.
“Two of Europe’s top courts arguing about the legality of bond-buying in the middle of a pandemic inject uncertainty into a market that doesn’t need it and does nothing to boost confidence,” said Kit Juckes, a strategist at Société Générale in London.
The euro, like many other major currencies, has shifted directions frequently this year. At the beginning of the coronavirus crisis in early March, the euro rallied sharply as investors scrapped risk-seeking trades funded with the currency, hitting a high of $1.1447. It then dropped to a low of $1.069 when companies and investors suffered a shortage of dollars. A calmer market environment since late March has seen it strengthen.
But the legal decision could limit the ECB’s ability to deliver on its pledge to help the euro area through the pandemic. If the central bank fails to convince judges that it is acting within its mandate, it could be forced to sell back German bonds it has already bought as part of its long-running “quantitative easing” programme. The size and flexibility of the bank’s Pandemic Emergency Purchase Programme could also be curtailed, denting hopes that the ECB could broaden the mix of assets it could buy at its June policy meeting.
“The ECB may now find it difficult to justify this flexibility . . . and maybe even to increase its size,” said Florence Pisani, global head of economic research at Candriam Asset Management. The ruling could also encourage other challenges to EU bodies from member states, she said. “In short, this is pretty bad news for Europe.”
But Stefanie Holtze-Jen, chief currency strategist at Deutsche Bank’s asset management unit said a lot of the risks associated with the eurozone have already been priced in prior to the decision, limiting the extent of the euro’s losses. “I think the currency is likely to stay within the $1.075-$1.1050 range . . . possibly until the end of the year,” she said
Broader concerns about the eurozone’s stability could also come to the fore. Bank of America Merrill Lynch expects the euro to hit $1.02 by the end of the year, as a result of the decision and other factors including a weaker global outlook.
Citi strategists said the ruling “creates major risks for the eurozone”, because the ECB could in theory ignore the decision and continue with its programme, a move that would come with considerable risks.
“Defying the German government could split the eurozone [and] cause a break-up from the core rather than the periphery,” Citi said. It has a three-month target of $1.10 for the currency.