Europe is composed of a mix of countries that are home to a beautifully diverse set of cultures and people. Unfortunately, its economic problems are just as diverse and nowhere near as beautiful. In this issue of Piponomics, we’ll take a look at the top issues that the major European currencies will face in 2013.
Euro (EUR): The Spanish Bailout and Weak Growth
We can’t deny that the European Union and European Central Bank (ECB) have made a lot of progress with regards to handling the region’s debt crisis over the past few weeks. Greece, for instance, has managed to successfully run a bond buy-back program with very little to no hitches. The country’s next tranche of aid has also been approved.
This doesn’t mean that the worst is over though. Spain will be next on the debt-pedestal as it needs to sell around 20 billion EUR worth of bonds before the end of January 2013. If it’s unable to, risk aversion may rise again and increase bond yields beyond Spain’s means. A scenario like this could result in another crisis as it will require Spain to ask for bailout funds.
The euro zone‘s growth rate is also an issue. The fact of the matter is that the region is suffering from a zero-growth environment, while other major economies have been expanding (no matter how slight). For instance, the U.S. has grown 2.7% in Q3 while the euro zone contracted by 0.1%. If this growth differential is sustained in 2013, it is likely to hurt EUR/USD.
Despite the potential problems, recent market sentiment seems to be generally positive, which suggests that EUR/USD could go even higher at least in the beginning of 2013.
British Pound (GBP): The Potential for Open-Ended Easing
In its most recent interest rate decision, the Bank of England (BOE) chose to leave both its benchmark interest rate and its asset purchase program unchanged at 0.50% and 375 billion GPB, respectively. The economy, the bank stated, has been showing signs of growth. Its GDP for Q3 2012 showed that the economy expanded 1.0%, which means that the U.K. is technically out of recession.
Nevertheless, it cannot be ruled out that the central bank may pull the quantitative easing trigger again in 2013. If the U.K.’s economy does not improve, there’s a decent chance the BOE will fire up the printing presses again.
In fact, some analysts are even predicting that the central bank will move to open-ended easing just as the Federal Reserve has done. This is bad for the pound, to say the least. In the month leading to the BOE’s June decision when the asset purchase program was expanded, GBP/USD actually lost almost 7% of its value.
The country’s PMIs seem to support this. The Manufacturing PMI for December came in at 49.1, which means that the industry is contracting. Meanwhile, the Services PMI fell for the third straight time. It printed a reading of 50.2, down from the previous month’s 50.6. And lastly, the Construction PMI dropped to 49.3 from 50.9.
All things considered, I expect the potential for further easing (open-ended or not) and the bleak economic outlook to weigh heavily on the pound.
Swiss franc (CHF): The Swiss National Bank’s Floor
The grim truth is that in Europe, practically every country has seen its fair share of economic problems. Even Switzerland, which is one of the richest countries in the world in terms of per capita income, has come under pressure.
The persistent strength of its currency and overall weaker global demand for its exports have made monitoring the exchange rate a top priority for the Swiss National Bank (SNB). And unless we see some drastic changes to the global economy, the central bank’s pledge to defend its currency will probably remain the key theme behind Swiss franc price action in 2013.
In particular, the markets will likely be keen on seeing if the SNB will adjust the minimum exchange rate of 1.2000 on EUR/CHF that it implemented in late 2011 and so grittily defended in 2012.
The SNB has never expressed how long it plans to keep the floor at 1.2000, but if you ask me, chances are that its minimum target will stay at this level for 2013… unless the euro zone’s economic situation worsens, that is!
If the euro zone’s manages to resolve its structural problems, it would go a long way in boosting confidence in Europe, lifting EUR/CHF in the process. But of course, there’s also a chance that the euro zone’s debt problems will take a turn for the worse and lead the Swiss franc to reprise its role as a safe haven currency.
Should that happen, it would likely pull EUR/CHF lower, and given enough pressure, could force the SNB to consider raising the floor from 1.2000.