Fed Rate Increase Prospects Drive Euro Down

The US Federal Reserve is expected to raise interest rates in September. In the meantime the EU is dealing with the Greek debt crisis which is at last showing some hope of resolution. The Financial Times looks at these two factors and notes that the Euro falls despite promising debt talks with Greece.

The euro’s recent resilience in the face of Greece’s stand-off with its creditors faded markedly on Tuesday, with investors focusing on the Federal Reserve’s first action to take US interest rates off historic lows.

Investors hit the single currency hard, pushing it down by as much as 1.9 per cent to $1.1134 against the dollar, and eurozone equities rallied sharply, building on Monday’s large gains.

The euro’s losses increased after a senior Federal Reserve policymaker said the central bank may raise rates twice this year. Jerome Powell, a member of the Fed’s board of governors, said the first move could come in September, although he also cautioned there was still only a 50-50 chance that the conditions would fall into place for that to happen.

Higher interest rates drive a currency higher. The slowly but surely improving US economy is set for a rate increase and the dollar is responding accordingly while Fed rate increase prospects drive the Euro down.

Stocks versus Currency

The prospect of a workable solution to the Greek debt crisis has lifted stocks on European markets but the prospect of a Fed rate increase is still weighing on the Euro. Reuters compares the optimism over the Greek situation with how a strong dollar is tempering the Euro.

Optimism that a deal could be at hand to stave off a Greek default lifted global shares on Tuesday and cut borrowing costs for the euro zone countries considered most vulnerable to the protracted crisis. European shares gained more than 1 percent to reach three-week highs and the risk premium that investors demand to hold Italian 10-year government bonds over German Bunds fell to its lowest for more than a month. Wall Street was also expected to open higher, according to stock index futures.

The euro missed the party, though. It fell more than 1 percent against a dollar boosted by further evidence of U.S. economic strength and against the yen and sterling.

A stable Eurozone is good for business so stocks in Europe have responded positively to news of workable Greek debt solution. And a cheaper Euro is good for European exports so the Fed rate increase that drives down the Euro may end up helping the European economic recovery!

European Business Index

The underlying business picture in Europe is brightening. Bloomberg reports that the European business index of factories and services is its best in four months with growth the best in the two major economies, Germany and France.

An index of euro-area factory and services unexpectedly rose to the highest in more than four years this month as growth gained momentum in Germany and France, the bloc’s two largest economies.

Markit Economics said on Tuesday that its composite index increased to 54.1 from 53.6 in May. That’s above the 50 mark that divides expansion from contraction and exceeds the median estimate of economists, who forecast it would slip to 53.5. France’s gauge of the two industries climbed to the highest since 2011 and growth in Germany also strengthened.

As the Fed rate increase prospects drive the Euro down it may only serve to improve the business picture in the EU.