Yes, yes, we know the real reason King Canute told the waves to stop was to show ‘how empty and worthless is the power of kings’.
Whereas Luxembourgish prime minister Jean-Claude Juncker was quite serious on Friday in telling markets that the euro was too strong at $1.40.
The waves did indeed stop — for a time (chart via Reuters):
But the trends heading towards a strong euro are already catching up with Juncker’s power of speaking for eurozone finance minsters in his capacity as Eurogroup head, plus his timing ahead of G7 negotiations.
In particular, Nomura pointed out on Friday that these trends go some way beyond the market frenzy for a QE-weakened dollar — focused on European Central Bank exit strategy:
While most major global interest rate markets have seen a relentless rally over the past few months, eurozone rates have been an outlier. 3-month Euribor bottomed in March-April below 0.60%. During June and July, Euribor shifted to around 0.80%, where it stayed until the end of September. But in the past few weeks, it has risen again to its current level of 0.90%.
Contrary to previous spikes in money market rates, this has not been the result of counterparty concerns in the interbank market. The driver has been changes in overall liquidity and a gradual rise in ‘risk-free’ overnight rates. This can be seen from the EONIA fixings, which have been drifting higher, and from 3-month EONIA swap rates, which have spiked from 0.50% in early September to 0.70% currently. The increasing trend in overnight rates has coincided with a reduction in excess liquidity in the eurozone banking system. Last week, excess liquidity dropped from more than €100bn to around €30bn as the take-up in the ECB’s unlimited 3-month operation was well below expectations.
As to the consequences of euro strength — Goldman Sachs fed their new call for a $1.55 euro into their European macro outlook on Friday.
It’s not looking good. As Goldman’s chief European economist Erik Nielsen observes:
[$1.55] implies a forecast for the real effective Euro that is almost 4% stronger in 12 months than we included in our previous growth forecast. On past experience, this would drag Euro-zone GDP growth down by about 0.3ppt. As a result, we have now lowered our 2011 GDP forecast to 1.8%.
A tighter-than-expected French 2011 budget supplied the other bit of downside, Goldman add — the price of fiscal cuts in the periphery looks less certain. As Nielsen continues:
A stronger Euro would also have a (slightly) moderating effect on the already well behaved inflation rate, slicing 0.1ppt off our previous forecast and bringing the 2011 average to 1.5%… For every 10% real effective Euro appreciation beyond the forecast, Euro-zone GDP growth is likely to be 0.9- 1.0ppt lower after about a year.
And for Goldman as well, the pace of ECB normalisation looms large in addition to QE2. Over to you, King Trichet.
Related links:
The euro desert – FT Alphaville