European currencies, which are already suffering due to the Russian-Ukraine war, are expected to take further blows from a looming euro-region recession.
Bloomberg’s data shows that traders of European currencies are more bearish particularly on the Hungarian forint, Polish zloty, and Czech’s koruna, compared to other currencies in developing nations, except for the Russian ruble and Turkish lira.
A Bloomberg article reports that Goldman Sachs Group Inc., Fidelity International, and InTouch Capital Markets all believe that if the euro weakens, the eastern European region will suffer more compared to other emerging markets.
The prior-named European currencies are especially susceptible to fluctuating demand from the 19-nation single-currency area, which purchases approximately 60% of each country’s exports. However, since the Russian invasion of Ukraine started in February this year, the countries have also been trading increasingly in lockstep with the euro.
Paul Greer, a money manager at Fidelity International, London, said that they are feeling cautious and bearish on the eastern European currencies and also betting on additional declines in the zloty and koruna against the US dollar.
He added that the region is the most vulnerable bloc among emerging markets within the currency space.
Bloomberg’s article said that although the International Monetary Fund had cautioned that the global economy may be on the verge of recession in July, the current prospects for the euro region is particularly bleak.
Inflation is at an all time high while the increased likelihood of a Russian energy cutoff is threatening to depress the single-currency bloc.
The eastern European currencies will likely experience the largest depreciation among emerging market currencies if the euro dips below dollar parity for an extended period, due to their exposure to euro-bloc demand and gas supply disruptions, a Goldman Sachs strategists stated.
Late in July, the US bank had revised its three-month euro target from US$1.05 to US$0.99.
Piotr Matys, a senior currency analyst at InTouch Capital Markets said that at this stage, Europe is far more vulnerable and as a result, it’s realistic to predict that the central and eastern currencies will under-perform particularly if the euro-dollar declines.
Decline in double-digits for European currencies
The article explained that the region has been among the most severely affected by Russia’s invasion of Ukraine. Since the beginning of the war, the forint declined 17% against the dollar with an 8.2% decline against the euro. Meanwhile, the zloty dipped by 12% against the greenback while the koruna fell 9.6%.
The increasing interdependence of these European currencies with the euro highlights the potential for further repercussions should the common currency weaken. All three currencies have an inverse correlation with the euro of approximately -0.8, where a -1 would indicate them moving in lockstep with the euro.
After plunging to a historic low against the euro in July, Hungary’s quick action to implement its monetary tightening policy has helped to stabilise the forint for now. Another factor weighing on the currency would be the fact that the nation has not yet acquired access to the European Union’s pandemic recovery fund.
Meanwhile, in Poland, the authorities have been making progress with the EU’s executives to access the recovery funds. Its country’s central bank is close to the end of its monetary tightening cycle and brought its key rate to 6.5% against the 10.75% in Hungary.
As for the Czech koruna, the article reports it to be the most stable due to the currency interventions implemented by the central bank. Early August saw its monetary authority maintaining its 7% interest rate, in line with the nation’s Governor Ales Michl’s plan to suspend aggressive monetary tightening.
Oliver Harvey, head of currency research for central and eastern Europe, the Middle East, Africa, and Latin America at Deutsche Bank AG, stated that the outlook for the region is mixed. Concerns about Hungary’s economy have already been factored in, and the koruna will likely begin lagging behind its regional rivals as the Czech Republic loses competitiveness and the rate of intervention slows, he added.
However, a euro declining below parity could spell the end for the three European currencies.
Harvey stated that CE3 would underperform if the move below parity is driven by euro-specific factors such as a further deterioration to the Russia-Ukraine war, and spillovers into the euro-zone economy.
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