Currencies: Euro plummets as uncertainty in Germany rattles markets

November 20
13:04 2017

The euro fell on Monday in Asia after Chancellor Angela Merkel’s efforts to form a government in Germany collapsed overnight, leaving the eurozone’s largest economy in political limbo almost two months after its general election.

The currency fell as much as 0.6% against the U.S. dollar EURUSD, -0.3901%  , though it has since recouped some of its losses, according to Thomson Reuters data. In recent action, the euro was down 0.4% at $ 1.1705. The euro also lost 0.5% against the Japanese yen EURJPY, -0.41%  and 0.4% against the British pound EURGBP, -0.4596%  .

Merkel’s conservative alliance won the September election but finished with its worst result since 1949, forcing the longtime German leader to try to cobble together a coalition with a majority in Parliament. That effort hit a roadblock late Sunday in Germany after the chairman of the small, pro-business Free Democratic Party ended talks with Merkel’s conservative camp and the center-left Greens.

Read: Merkel’s future in doubt as German coalition negotiations break down

“It’s very concerning, and creates this big uncertainty in the eurozone,” said Kisoo Park, a global bond manager at Manulife Asset Management in Hong Kong, adding that he expects the euro to fall further in the short term.

The collapse of coalition talks in Germany is the latest episode of political turmoil to hit the region. Spain has cracked down on the region of Catalonia after it declared independence following a referendum the Madrid government had deemed illegal. Meanwhile, the U.K. has made little progress in its divorce proceedings from the European Union, which has major implications for trade and the common currency.

The prospect of prolonged political uncertainty in Germany is particularly worrying for markets. Merkel has long been seen as Europe’s pre-eminent political leader, having steered Germany through both the global financial crisis and the subsequent crisis in Greece.

Her decision to let in hundreds of thousands of refugees and migrants from Syria and other countries in 2015 stoked strong domestic opposition, however. Anti-immigration party Alternative for Germany performed strongly in September’s election, winning some 13% of the vote.

“Germany has been the more stable country in the region and globally, but if that goes away, then that could cause a cascade of fallouts,” said Park, citing possible effects on the Brexit talks and parliamentary elections due next year in Italy.

Merkel will continue to lead a caretaker government in Germany for now. The chancellor could try again to woo enough parties to form a ruling coalition, or attempt to run a minority government. A further option is for Germany to have a fresh general election.

Despite periodic political problems in Europe this year, the euro has surged nearly 12% against the U.S. dollar. The common currency has also advanced roughly 7% against the yen and 4.4% against the British pound so far in 2017.

“What we’ve seen globally is a shift to more extreme parties. The euro has managed to ride this out, and the reaction in the euro [this year] has been much more dependent on growth,” said Mitul Kotecha, head of Asia foreign-exchange and rates strategy at Barclays in Singapore.

The eurozone economy is on track for its strongest year since 2007, though growth slowed slightly in the third quarter and inflation fell. That combination of improved economic growth and low inflation should ensure that the European Central Bank will begin reducing its monthly bond purchases slowly, much like the Federal Reserve, as it begins to unwind its easy monetary policy.

Kotecha said he still expects the euro to end 2017 at $ 1.17, near its current level, and he expects the euro to rise further next year, driven by improving growth and a weaker dollar.

The WSJ Dollar Index BUXX, +0.13%  rose 0.1% on Monday to 87.21, helped by the euro’s decline. Investors continue to focus on the odds of a tax bill passing in the Senate, which is scheduled for a vote after Thanksgiving.

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