Top: French President Emmanuel Macron. Copyright: European Union.
Fresh uncertainty seemed to rattle the euro on Tuesday, with euro zone government bonds falling and talk of the French president's possible resignation.
The pound-to-euro exchange rate continues to rise as investors grow increasingly nervous about the euro zone's outlook. The gap between French and German government bond yields is at its widest since 2020, a classic sign of investor anxiety.
Bond yield premiums have also risen in other euro zone countries, in an apparent sign that the results of the weekend's euro zone elections are dealing a blow to the trust holding the euro zone's financial system together.
Admittedly, we are not in a crisis, but it does suggest that optimism about a euro peak may be fading.
Confidence was further dented after Europe 1 radio reported that French President Emmanuel Macron was considering the possibility of resigning if the upcoming general elections performed poorly, though sources close to the president reportedly denied this.
These news are just the latest in a series of events signaling growing political uncertainty in the euro zone, which has been weighing on the euro exchange rate and bond markets.
The British pound surged against the euro on Monday after euro zone elections saw French President Emmanuel Macron call general elections and Germany's ruling coalition suffer a major defeat. The rally comes after the Office for National Statistics reported that British wages rose 6.0% in April, a figure too high for the Bank of England, which is trying to lower inflation to 2.0%.
Indeed, the UK unemployment rate is also rising, suggesting continued weakness in the labour market, but the Bank of England will have to proceed cautiously with any interest rate cuts. A slow and cautious cycle of interest rate cuts would be consistent with continued support for the pound.
The euro is arguably the bigger driver of the pound-euro relationship at present, with a notable political risk premium emerging, helping to push the pound-euro pair to a 34-month high of 1.1863 and lifting payouts with rival providers to above 1.18.
Above: GBP/EUR on a daily chart. Track GBP/EUR with your own custom rate alerts. Set here
“The euro continues to weaken following the results of the European Parliament elections on Sunday,” said Achilleas Georgoropoulos, investment analyst at XM.com. “While France's hastily convened parliamentary elections have attracted the most attention, the main event of the weekend was the very weak showing by Germany's three coalition parties.”
Analysts say the election is of note for Germany, as support for the coalition government, which won around 51% of the vote in the 2021 federal election, has plummeted to just 31%, raising doubts about the viability of the current government.
“Germany is considered the 'sick man' of the eurozone. A court ruling at the end of 2023 will also limit the government's fiscal space in 2024. Although new federal elections are not scheduled, a weakened German chancellor could have serious consequences,” Georgoropoulos said.
Growing political uncertainty in the eurozone contrasts with the relatively mundane political situation in the UK, with investors well prepared for a big Labour victory on the 4th of July.
Indeed, Labour is relatively close to the current Conservative government in terms of economic policy, suggesting continuity for businesses.
“The market has little information about Labour's economic policies but is likely to view any shift away from the policy turmoil of recent years as a welcome one. The UK stock market could benefit,” said Chris Igo, chairman of AXA IM investment research institute. “Equities are cheap and so is the pound.”
More than half of the 268 respondents to a Bloomberg investor survey said a Labour victory would be best for the pound.
That is, in contrast to the more uncertain outlook for the euro area, a pro-pound political establishment has emerged, which is reflected in a rise in the pound-to-euro exchange rate.
“European regional politics currently faces a lot of challenges. The expected rise in support for far-right groups in the European Parliament elections reflects growing support for issues such as nationalism and cultural identity, which could have implications for EU enlargement, common European initiatives (such as climate change) and Ukraine-related policy,” said Jane Foley, senior FX strategist at Rabobank.
Rabobank expects the euro exchange rate to weaken going forward, keeping its one-month EUR/USD forecast at 1.07. It also expects the euro to weaken against the pound and the krona.
