Where next for the Euro amid record-breaking inflation?

According to the Bank of International Settlements, EUR/USD is the most traded major currency pair in the world, making up 24% of all trades. And it’s not hard to see why, as it encompasses the two largest market economies in the world— the USA and the European single market.

The Bank of England estimates that the EUR/USD saw an ‘average daily turnover of $913.6 billion in April 2021, reaching all-time highs.’ But right now, 55% of IG clients are long on the pair, as significant uncertainty continues over whether the US dollar or the Euro will strengthen first.

EUR: record-breaking inflation

Eurozone inflation hit 5% in December, a second record high after November’s figure of 4.9%. And with energy costs soaring 26% over the past year, it’s now consistently higher than the ECB’s 2% target. And the inflation spike comes as the Omicron variant washes over Europe, forcing new restrictions that could send inflation even higher. But President Christine Lagarde is defying intensifying pressure to increase interest rates, with some newspapers now labelling her as ‘Madam Inflation’ and ‘Luxury Lagarde.’

And the energy crisis appears to be worsening. In the week before Christmas, futures contracts linked to wholesale gas prices soared to a record high of €180 per megawatt, causing ships carrying liquefied natural gas (LNG) bound for Asia to change course mid-voyage. And while Rystad Energy consultancy estimates that the 7.3 million tonnes of LNG delivered to Europe in December helped to stabilise prices at €90 per megawatt-hour, this figure is still up 350% in a year. As confrontation with Russia over Ukraine persists, the consultancy predicts ‘continued elevated prices.’

And it’s not alone in this prognostication. HSBC economist Fabio Balboni expects ‘wholesale gas prices to stay high until the spring of 2023,’ while CIO of BRI Wealth Management Dan Boardman-Westman believes ‘energy is going to continue to drive inflation up over the coming months.’ And French Finance Minister Bruno Le Maire thinks electricity price rises of up to 40% are coming ‘if we don’t find a solution in the coming days,’ while Poland has already VAT on car fuel after inflation hit a 21-year high of 8.6%.

German energy crisis

But arguably, Germany is facing larger struggles than its EU counterparts. Finance Minister Christian Linder believes ‘we have to do something’ over household heating costs. However, Germany’s new Chancellor, Olaf Scholz, has a significant problem when it comes to energy. As part of Angela Merkel’s popular post-Fukushima ‘Energiewende’ timetable, the country is completely shutting down its remaining three nuclear power stations by the end of this year.

And according to the US Energy Information Administration, Germany is the largest energy consumer in Europe, with imports accounting for 71% of its energy use. In 2019, petroleum accounted for 35% of the country’s energy consumption, natural gas represented 25%, and coal 18%.

Moreover, nuclear power represents 12% of its domestic energy generation— and this will need to be replaced with either more fossil fuels or other renewables. The country aims for consumed electricity from renewables to hit 65% by 2030, and 100% by 2045. The latter target is five years faster than both the EU and UK.

But Agora Energiewende estimates that Germany will need about 1,000 terawatt-hours of power by 2045, about double Germany’s consumption in 2020. The gap between future energy requirements and current energy generation is widening, leaving Germany open to spiralling import costs.

This nuclear issue has opened a political rift between the Union’s two largest economies. The European Commission has issued a draft proposal to label nuclear energy as a green source of energy under its carbon-neutral plans. The proposal is strongly supported by France, where over 70% of energy is nuclear-powered, but Germany’s Environment Minister Steffi Lemke believes it would be ‘absolutely wrong’ to include nuclear in the plans because it can ‘lead to devastating environmental catastrophes.’

However, Michael Liebriech, Chairman of Liebriech Associates, has called Germany’s nuclear shutdown an ‘epic, epic mistake’ and ‘a climate crime.’ The country’s Europe Minister Anna Luehrmann has stated that the two nations will ‘agree to disagree,’ accepting that ‘we are not the majority in Europe.’

With the Eurozone’s largest economy likely to become even more reliant on imported energy, inflation is likely to soar through 2022. And with EU member states disagreeing on its common energy policy, pressure on the ECB to raise rates could soon reach maximum intensity.

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* Based on revenue excluding FX (published financial statements, October 2021).