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    Paris attacks unlikely to derail Eurozone recovery but may dent confidence, weigh on ECB policy

    Last Friday’s terrorist attacks in Paris, France, which have so far killed 129 people, have cast a shadow on the fragile recovery in the Eurozone. It is worth reminding that third quarter growth in the euro area came in below expectations and the Eurozone economy expanded by a meagre 0.3% quarter-on-quarter. The European Central Bank has already been signalling for weeks now that it will review its current stimulus measures at its next policy meeting on December 3 where it will consider additional action to boost inflation across the Eurozone.

    The unfolding events over the next few weeks could determine whether last week’s attacks will have a long lasting impact on economic growth in France as well as in other Eurozone member states. The new incidences today of gunfire and explosions in a northern suburb of Paris, and the diversion of two Air France flights from the US to Paris, have further darkened the mood across France.

    The EU Economics Commissioner Pierre Moscovici said on Tuesday that the EU executive could offer budget leeway to France to spend on added security measures. ECB policymakers have also lent their support to France and the tragic events could provide them with an added justification to loosen monetary policy in December. The increased government spending and extra ECB stimulus increase the prospects of higher growth in the long run even if some negative short term impact takes hold.

    ECB Vice President Vitor Constancio said on Monday that the Paris attacks could lead to events that would undermine confidence and that the ECB has further stimulus options if needed to incentivize risk-taking. The view was reiterated by another ECB official Peter Praet on Tuesday who is concerned that the downside risks may have increased since the attacks. However, another ECB board member Yves Mersch said on Wednesday that it was too early at this stage to say whether the attacks are having any impact on the Eurozone economy.

    The overall tone from ECB policymakers in recent days has been to stress the downside risks to inflation in the Eurozone, signalling that the ECB is paving the way to expand monetary policy at its next meeting. Markets have already priced in a 0.1% reduction in the deposit rate to -0.30% and some reports are suggesting that the ECB will add municipal bonds to its list of asset purchases.

    Reaction in financial markets in response to the attacks was fairly muted. European equities were mixed on Monday with the majority of the indices closing slightly down from Friday’s close. However, share prices posted strong gains on Tuesday and market focus is back on the diverging monetary policies between the US and the Euro area.

    The euro has seen a slightly stronger reaction to the recent events, which have added some uncertainty over the Eurozone outlook. Together with the heightened expectations of the ECB taking action in December, the single currency is likely to come under increased pressure in the near term. The euro tumbled below 1.07 dollars on Monday for the first time since April. It continues to trade near 7-month lows against the dollar and was up marginally today at 1.0661 dollars in mid-European session. Against the yen, the single currency hit a 7-month low of 130.64 yen on Monday but had recovered to 131.51 yen today. Meanwhile the pound surged to a 5-month high, pushing the euro below 70 pence on Tuesday. The euro bounced back today to climb to 0.7001 pounds.

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