EUR: The big disappointment from Germany
The German Constitutional court's ruling reinstated a risk premium into the EUR. While negative for the euro, for now, we don’t see the same risk premium built into EUR/USD as was observed after the March ECB meeting - the ECB is still in the market and has three months to respond. We think, EUR/USD to stay above 1.07, but downsides risks are building
PSPP constitutes an economic policy
The German Constitutional court ruling reinstated a risk premium into the euro today.
While the court dismissed the idea that the European central bank purchases constitute monetary financing, it ruled that PSPP purchases constitute an economic policy and are therefore out of the ECB remit. The court also gave the ECB and Bundesbank three months to fix the issue.
Disappointment for markets as ECB measures had been containing EUR risk premium
The euro reacted negatively given that:
(a) such a ruling was not expected, hence the disappointment effect;
(b) in the current times of stress, the ECB easing measures (including the PSPP programme) have had a risk premium reducing the impact on the euro (decreasing the odds of the renewed eurozone fiscal crisis and keeping BTP-Bund spreads contained).
The second point is crucial for the euro and its outlook as the risk premium containment measures have been the key prerequisite for a more meaningful EUR/USD upside going into the summer months.
But the impact shouldn't be as bad as it was in March, at least for now
Following the ruling, we estimate EUR/USD to trade with around 1% risk premium (Figure 1). This is still below the around 2% risk premium observed after the March ECB meetings and President Christine Lagarde’s miscommunication during the press conference.
However, in our view, the near-term outlook for the euro was more negative back in March than it is today, given that back then it was the ECB that appeared unwilling to contain the market stress. Hence, the euro risk premium may not reach the 2% level or more in coming days and EUR/USD stays above 1.07 as (1) the lender of last resort is willing to do 'whatever it takes' to deliver the financial stability (though maybe eventually constrained by the court ruling); (2) there are still three months to find a solution / to challenge the German court ruling.
Both options should reduce the imminence of the worst-case outcome when compared to March and hence shouldn't be as detrimental for the euro.
Figure 1: EUR risk premium today less than it was in March
Contained EUR/USD until we have more clarity on the response
Rather than a profound decline in EUR/USD (where a degree of risk premia is already priced in), today’s ruling should contain its upside and make it more difficult for the EUR/USD to profoundly and persistently break above the 1.10 level – until there is more clarity on the future of the ECB purchases.
Equally, a more meaningful EUR/USD downside (below 1.07) cannot be ruled out, but in our view, first, we need to see the ECB response and its implications for asset purchases.
Download
Download article"THINK Outside" is a collection of specially commissioned content from third-party sources, such as economic think-tanks and academic institutions, that ING deems reliable and from non-research departments within ING. ING Bank N.V. ("ING") uses these sources to expand the range of opinions you can find on the THINK website. Some of these sources are not the property of or managed by ING, and therefore ING cannot always guarantee the correctness, completeness, actuality and quality of such sources, nor the availability at any given time of the data and information provided, and ING cannot accept any liability in this respect, insofar as this is permissible pursuant to the applicable laws and regulations.
This publication does not necessarily reflect the ING house view. This publication has been prepared solely for information purposes without regard to any particular user's investment objectives, financial situation, or means. The information in the publication is not an investment recommendation and it is not investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Reasonable care has been taken to ensure that this publication is not untrue or misleading when published, but ING does not represent that it is accurate or complete. ING does not accept any liability for any direct, indirect or consequential loss arising from any use of this publication. Unless otherwise stated, any views, forecasts, or estimates are solely those of the author(s), as of the date of the publication and are subject to change without notice.
The distribution of this publication may be restricted by law or regulation in different jurisdictions and persons into whose possession this publication comes should inform themselves about, and observe, such restrictions.
Copyright and database rights protection exists in this report and it may not be reproduced, distributed or published by any person for any purpose without the prior express consent of ING. All rights are reserved.
ING Bank N.V. is authorised by the Dutch Central Bank and supervised by the European Central Bank (ECB), the Dutch Central Bank (DNB) and the Dutch Authority for the Financial Markets (AFM). ING Bank N.V. is incorporated in the Netherlands (Trade Register no. 33031431 Amsterdam).