Why is the euro surging against sterling and the US dollar?

The euro’s move above $1.20 level against the US dollar for the first time since January 2015 marks a symbolic moment in the strengthening European economy. Sterling investors will also wince at an eight-year high for the euro against the pound.

As recently as last November some imprudent analysts were predicting the euro would reach parity with the US dollar this year, as the greenback surged and the European economy lagged. Those bets are now off. Here’s why.

Why was the euro so weak?

Last summer the Eurozone economy was not in a particularly impressive state. Growth was meagre, while the European Central Bank (ECB) had increased its monthly bond purchases, known as quantitative easing (QE), to €80bn in a seemingly desperate attempt to stimulate the economy.

The various ills of the Eurozone translated into an extended period of weakness for the euro. The single currency struggled to break through the $1.15 level against the US dollar, and fears of stagnant growth dominated.

What has happened to the European economy since then?

In the last year all signs have pointed upwards for the European economy. Unemployment has continued to fall, the threat of damaging deflation has receded, and growth, at 0.6 per cent in the second quarter, was double that of the UK.

What does this mean for monetary policy?

ECB president Mario Draghi faces a tricky task in the coming months in communicating the taper of QE, but the fact that reducing stimulus is on the cards shows how far the Eurozone economy has come.

Draghi’s every word is being scrutinised for signs that he will reduce the size of bond purchases after December, in effect tightening (albeit cautiously) the supply of money flowing into the economy. A more hawkish stance (implying faster tapering) would lend even more support for the euro.

What about the political situation?

Stronger growth has been accompanied by market-friendly political outcomes. Elections in the Netherlands and Austria saw populist politicians comfortably defeated by mainstream candidates. That was followed by the victory of independent, centrist challenger Emmanuel Macron in the French presidential elections in April and May.

European politics has likely not seen the last of his far-right opponent, Marine Le Pen, and her like, but the win for Macron, a former banker bent on reforming the EU, proved to be the trigger for an almost unbroken rally in the euro.

What has Trump got to do with it?

The euro’s rise has been impressive across the board, with the ECB’s trade-weighted euro index reaching its highest since September 2014. Yet as with most currency stories, the dollar also plays a crucial part.

After Donald Trump’s election as US President the dollar surged against other major currencies, with investors expecting some form of tax reform (in the form of big cuts) and a boost in infrastructure spending. Trump’s campaign promises added up to a de facto fiscal stimulus, which would force up inflation.

However, after successive failures to pass major legislation, investors have started to doubt whether anything will be passed and have sold the dollar. Some optimists are still holding out hope, but any bill is likely to be much delayed or watered down at the very least.

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