The euro starts strong in July against the pound, but faces an increasingly difficult outlook

  • Eurozone CPI Burns, Supports Euro
  • Market already bearish on UK and GBP
  • But the euro could be on the verge of a sentiment downgrade
  • As Barclays predicts a winter recession
  • Berenberg agrees, citing the M1 money supply lockdown

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The euro strengthened in the first trading session of July as investors digested inflation data that showed prices in the eurozone continued to rise, raising bets for a move. from the European Central Bank, but the single currency faces a tough outlook as some economists warn of an impending recession.

The euro outperformed the pound on the day Eurostat revealed that eurozone CPI inflation stood at 8.6% year-on-year in June, up from 8.1% in May and beating expectations of a reading of 8.4%.

Italy reported a significant 1.2% jump in prices during the month of June, beating expectations for growth of 0.6%, bringing the year-on-year change to 8.0%.

It comes after Spain reported that its CPI growth hit a record 10% year-on-year in June.

The data is mounting pressure on the European Central Bank to raise interest rates and a significant 50 basis point hike in July can no longer be ruled out. The exchange rate between the pound and the euro fell half a percent overnight to stand at 1.1550.

Currency and money market reactions and price responses suggest that overall this supports the Euro.

“A few weeks ago I argued that the ECB could not exit negative rates all at once because of the impact it would have on financial stability. But with rates and bond markets now properly primed, there seems to be no excuse for pulling the trigger to 50 basis points,” says Simon Harvey, head of research for Monex Europe.

Inflation may now support the euro, but it could soon turn into a real headwind as it dampens growth and pushes the eurozone economy into a period of stagflation.



Barclays economists this week revised their economic forecast for the eurozone and now say they expect a eurozone recession by winter.

“We expect below-consensus growth in the euro zone over the summer and a recession in the winter, based in part on falling real incomes,” said Mark Cus Babic, macro research analyst at Barclays.

A downward recalibration of eurozone growth expectations against the UK could ultimately support the exchange rate between the pound and the euro as currency markets continue to observe the differing fortunes of major economies.

NatWest Markets economists said earlier this month that the pound’s continued decline against the dollar and euro reflected economists’ pessimism about the UK’s economic growth outlook for 2023.

This is summarized in the chart below detailing changes in economists’ expectations for growth in 2023:


Peak of pessimism towards the GBP

Above: Consensus GDP expectations for 2023. Source: Bloomberg, Natwest.


NatWest currency strategist Paul Robson said last week he believed the peak of pessimism over the UK economy and the pound was now potentially reached, leaving the euro more exposed to the downside if growth forecasts of the euro zone are revised downwards.

Barclays says eurozone households have saved more of their income during the pandemic, but the savings rate is now close to its pre-crisis level, leaving little cushion for consumers as they are affected by soaring prices.

They find that, in the case of Germany, the excess savings that consumers can fall back on in the face of rising inflation is now effectively zero.

“It’s not because German households decided to spend excess cash, since they were still accumulating financial assets (cash plus other) at about the same rate as the whole EA. Instead, in the face of bloated bank balances, Germans hoarded cash at a lower rate than before the pandemic and diverted that money to the stock market, bringing the cash balance closer to its pre-pandemic trend. pandemic,” says Babic.

Barclays has significantly lowered its euro zone real GDP growth forecast for 2023 and expects a technical recession to be in place by the end of the year in all countries.

Berenberg Bank economists, meanwhile, say M1 money supply in the eurozone is now flashing red.

“Over the past 30 years, no chart or model has served us better in predicting Eurozone growth than a look at the currency. Real money supply M1 often heralds major turning points in the business cycle around two to three quarters ahead. Unfortunately, the chart’s message is clear: judging by the real value of the very liquid balances of households and non-financial corporations, the euro area is heading for a slowdown,” says Holger Schmieding, Economist chief at Berenberg.


M1 and probability of recession


A recession early in the year would mean that the European Central Bank has a very limited window to raise interest rates in an effort to bring down inflation.

The fall in expectations of an ECB rate hike would in turn weigh mechanically on the euro and provide support for the GBP/EUR parity, all other things being equal.

Underlining the importance of relative growth expectations for exchange rates, the euro’s decline last week following the release of PMI data which showed the eurozone economy slowed sharply in June due to the slower demand growth.

The Eurozone Composite PMI came in at 51.9, meaning the Eurozone economy was about to fall below the key 50 level, which marks the boundary between growth and recession. contraction.

“The subcomponents of the survey suggest a dip below this level in the coming months,” says economist Giovanni Zanni of NatWest Markets.


2022 NatWest Truck Mileage

Above: “Real-time indicators point to a slowdown in the second quarter,” says NatWest, citing the ability of truck mileage data to indicate the health of the economy.


Meanwhile, the equivalent UK PMI data came in above expectations which supported the pound against the euro.

If the market continues to downgrade Eurozone growth expectations over the next few days and weeks, Euro weakness could evolve, especially against the Pound, as UK economic sentiment may have already reached its peak of negativity.

“Admittedly, the economic outlook in the UK looks increasingly difficult as price hikes, particularly for fuel and energy bills, hit consumers’ wallets. But the economy is expanding, the Labor markets are tight and prices are rising, so we still expect the Bank of England (BoE) to rise four times more before the end of the year,” says Thomas Flury, strategist at UBS.

UBS expects the euro-pound to trade around 0.85 for the rest of the year, or 1.1765 in pound-euro terms. (Set your exchange rate alert here).

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