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Where did it all go right for the euro?

SPONSORED CONTENT - The European currency is alive and kicking. Jake Trask, research director at forex house OFX, explains how the euro became a strong and stable currency, and the outlook for investors.

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Is the euro a strong and stable currency?

The difficulties of the eurozone in particular the problems inherent in a bloc with one monetary policy and many different fiscal policies are well known. However, looking at its long-run story against the dollar, the striking fact is that one euro is worth pretty much the same today (around $1.18) as it was when it launched on 1 January 1999 (at $1.16).

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For a currency whose demise has been constantly predicted ever since its birth, that's not a bad record. In addition, the euro's record against sterling is not merely level-pegging, but one of strength: from its launch to today, one euro has appreciated from 70p to 88p.

Of course, during its 19 years of life, the euro has seen big fluctuations in its value. In its first couple of years it struggled, sinking quickly to an all-time dollar low of merely $0.84 by October 2000.

However, for the following eight years, the euro's story was one of sustained appreciation and it almost doubled in value to an all-time peak of $1.60 in July 2008 and a lifetime sterling peak of 96p in December that year.

What has happened since then?

After rising from 2000 to 2008, the euro then spent the eight years following the global financial crisis heading straight back down again, with spikes and troughs through the eurozone crisis to hit a bottom of $1.05 in December 2016.

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A year ago, then, it looked as if it was heading down to parity with the dollar, a level not seen since 2002. But then something startling happened. In 2017, the euro surged against the dollar (to about $1.18), the yen and the Swiss franc, among others, to become the best-performing major currency.

Against sterling, it appreciated from about 85p to around 88p. That's not as big a rise as against the dollar (the pound itself has been appreciating against the dollar this year, after its post-referendum crash of 2016), but it's still an impressive turnaround.

Why has the euro turned the corner?

There are three main reasons why the euro has hit back.

First, unexpectedly strong and apparently sustainable economic growth in the eurozone has prompted a more constructive inflation outlook from the European Central Bank.

According to last projections from the Organisation for Economic Co-operation and Development (OECD), the eurozone will have grown more in 2017 than the US, where the anticipated "Trump bump" following the election of President Donald Trump has proved disappointingly modest.

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Second, reduced political risk has been crucial. In particular, the defeat of right-wing populists in elections in France and the Netherlands settled nerves over further fracturing of the EU post-Brexit, although September's inconclusive election in Germany dampened the mood somewhat.

Finally, for a variety of economic and political reasons, the other major currencies have proved weaker than expected.

Will the euro carry on gathering strength in 2018?

Some analysts think so but as we've seen many times, there are no certainties when it comes to predicting currency movements.

As recently as four months ago, when the euro was rising sharply against sterling and hit 93p, analysts at one household-name US bank predicted that ongoing political uncertainty over Brexit and UK economic weakness meant euro/sterling parity was likely by early 2018.

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In the following month of September, however, the euro promptly fell back again and the idea it will be worth 100p early in the New Year for the first time ever now looks very remote.

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What we do know for sure is that both the euro and sterling are currently highly sensitive to political developments and what these imply about economic performance.

What should investors look out for?

Factors to watch out for include: the progress of Brexit trade talks; the possibility of political paralysis and a lack of leadership from Germany if Angela Merkel can't stitch together a coalition; and the rise of populist, anti-EU sentiment in several central and eastern European nations.

In addition, the euro is likely to benefit from what many analysts think will be a macro landscape that favours an ongoing depreciation of the US dollar namely a steady recovery in global growth and a signs of central banks converging on a more hawkish approach to monetary policy.

All that said, however, the euro's strength this year has been a major surprise. Expect more of that to come in 2018.

Ask the expert

Jake Trask, FX research director at OFX

Is the eurozone crisis really over?

For the time being, the immediate danger of the eurozone collapsing has been averted, but it could re-emerge further down the line. The French election, which was huge risk earlier in the year, saw far-right leader Marine Le Pen comfortably defeated by Emmanuel Macron, meaning Le Pen was unable to carry out her threats to reintroduce the franc.

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The situation in Greece has stabilised with it now running a budgetary surplus. Spain's economy, which suffered badly during the financial crisis, has also bounced back over the past three years. The French economy is performing well and Germany's economy is booming, with recent manufacturing surveys posting all-time highs.

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Despite the positive turnaround over the past year, there are still significant dangers that could envelope the bloc. Primarily, the health of the Italian banking sector with the nation's lenders balance sheets riddled with bad loans. The Italian general election is due to be held in March and, should the anti-establishment 5-Star party win, it could trigger a series of events which may lead to a referendum on European Union membership. So although the eurozone is looking stable for now, it's hard to predict what next year may bring.

How much of a threat is the political uncertainty in Germany?

Currently, the threat is not huge to the stability of the eurozone. However, it will continue to cause concerns as we head into the New Year. The main political parties in Germany are all pro-euro; however, smaller anti-EU parties made notable gains in the recent election, raising concerns amongst investors. The AfD party won 13.5% of the vote from a starting point of zero and will be the first overtly nationalist party to enter the Bundestag since the Nazis.

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Throughout the election campaign, the party's performance marked a major shift in Germany's postwar politics and is likely to produce a very different environment inside the Bundestag. We will have to wait and see if this elicits any change in tone from Germany on issues within the European Union.

Is the euro strong, or have the other big currencies been weakened by events from the past year?

The euro is relatively strong at present. However, ongoing monetary stimulus from the European Central Bank (ECB) has meant the currency hasn't reached the levels seen in 2013-14, when it was trading close to US$1.40. Should the ECB withdraw stimulus by the end of 2018, and provided the economy continues to perform well, the euro's gains may mean it pushes through the US$1.20 mark again and drops against the pound to below £1.10.

If Brexit trade talks proceed smoothly, will the euro depreciate against oversold sterling?

Should Brexit talks progress as the UK would like, then the upside for sterling will outweigh the gains for the euro. A smooth transition period leading to a favourable trade deal will be hugely pound-positive. It is, however, highly unlikely that negotiations will be plain-sailing given the EU's insistence that the UK shouldn't be better off outside the bloc than in. The EU has made it clear the UK will not be allowed to have its cake and eat it', so we anticipate plenty of headwinds ahead in 2018 for the pound.

How is OFX helping clients mitigate risks from market volatility?'

Our currency specialists at OFX work closely with clients to develop the right currency strategy, taking into consideration each of their unique circumstances and objectives. Using a range of products, we help clients mitigate risk, while ensuring they have a sustainable currency plan to navigate through market uncertainty. One product commonly used is a Forward Exchange Contract. This product allows clients to buy euros, for example, at the current rate. This can then be used up to one year in the future, locking in rates beforehand and removing the risks associated with currency volatility. It pays to use a third-party currency expert like OFX to ensure you always keep your bottom line in shape.

For more information from OFX on currency strategies and other matters, please click here

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