What’s driving the Euro's sharp rally?

The euro has surged higher in the past few days, rallying to a more than two month high around the 1.11 mark versus the dollar.

As mentioned in our report yesterday, the common currency has been well supported by the news of a 750 billion euro EU common fund, that is expected to see grants and loans made available to those countries worst affected by the pandemic. We have mentioned in the past few weeks that we thought a more sustained rally in the euro was on the cards, and that is exactly what we’ve seen in the past week, particularly against the dollar.

Not only has the news of fiscal support raised optimism regarding a Euro Area recovery, but we are continuing to see a dichotomy in both the spread of the virus and economic resilience between the US and Europe. New daily cases of the virus are continuing to ease at a rapid pace in Europe, while remaining elevated in the US and hampering efforts to unwind lockdowns at the rate witnessed in the common bloc.

Meanwhile, the US labour market continues to shed jobs at an aggressive pace, compared to the very mild increases in unemployment we are seeing in Europe. Another 2 million Americans filed for unemployment benefits last week, taking the total since the start of the crisis to 40 million (approximately 25% of the total labour force. A downward revision to the Q1 US GDP data (-5% QoQ versus the -4.8% original estimate) and massive declines in both April durable goods orders and home sales also far from helped the dollar yesterday.

A big test for the EUR/USD pair will be next week’s ECB meeting. We think that the bank will announce an increase in its pandemic purchase programme, which may (somewhat paradoxically) provide additional support for the common currency, in our view.

BoE’s Saunders hints at negative UK interest rates

Sterling also rallied against the broadly weaker dollar on Thursday, although its gains were contained to around half a percent.

There remain a number of forces preventing a more sustained move higher in the pound - the market pricing in the possibility of negative Bank of England interest rates, Brexit uncertainty and the UK’s growing pile of debt made worse by the government furlough scheme. MPC member Michael Saunders commented on the former yesterday, warning that further rate reductions may be in the offing. He stated that it would be better for the bank to inject too much stimulus into the UK economy than too little given the seriousness of the economic threat posed by the virus.

With no major economic data out of the UK today, the pound may be driven by events elsewhere.