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Factors Affecting Major Currencies

The Eurozone: The 18 countries that have adopted the euro as their national currency are: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

European Central Bank: Controls the monetary policy of the Eurozone. The ECB’s decision-making body is the Governing Council, which consists of the Executive Board and the governors of the national central banks of the Eurozone countries. The Executive Board consists of the ECB President, Vice-President, and four other members.

ECB Policy Targets: The primary objective of the ECB is price stability, which consists of the two main "pillars" of monetary policy. The first one is the outlook for price developments and risks to price stability. Price stability is defined as an increase of the Harmonized Index of Consumer Prices (HICP) of below 2%. While the HICP is important, a broad number of indicators and forecasts are used to determine the medium-term threat to price stability. The second pillar is monetary growth as measured by M3. The ECB has a "reference value" of 4.5% annual growth for M3.

The ECB holds a Council meeting every other Thursday, and makes announcements on interest rates. After each first meeting of the month, the ECB holds a press conference in which it gives its outlook on monetary policy and the economy as a whole.

Interest Rates: The ECB’s refinancing rate is its key short-term interest rate used for managing liquidity. The difference between the refinancing rate and the US Fed Funds rate is a good indicator for the EUR/USD.

3-month Eurodeposit (Euribor): EUR-denominated deposits at banks outside the Eurozone are called Euribor deposits. The interest rate on 3-month Euribor deposits held in banks outside the Eurozone serves as a valuable benchmark for determining interest rate differentials to help estimate exchange rates. Using a theoretical example on EUR/USD, the greater the interest rate differential in favor of the Euribor against the Eurodollar deposit, the more likely EUR/USD is to rise. Sometimes, this relation does not hold due to the confluence of other factors.

Another key factor of the EUR/USD exchange rate is the difference in interest rates between the US and the Eurozone.

10-Year Government Bonds: Another key factor of the EUR/USD exchange rate is the difference in interest rates between the US and the Eurozone. The German ten-year Bond is normally used as a benchmark. Since the rate on the ten-year Bond is below the US ten-year note, a spread narrowing (i.e. a rise in German yields or a fall in US yields, or both) is theoretically expected to favour the EUR/USD rate. A widening in the spread will act against the exchange rate. So the ten-year US-German spread is an important number to remember. The trend in this number is usually more significant than the absolute value. Naturally, the interest rate differential is usually related to the growth outlook of the US and the Eurozone, which is another fundamental factor of the exchange rate.

Economic Data: The most important economic data comes from Germany, the largest economy, and from the euro-wide statistics still in their infancy. Key data are usually GDP, inflation (CPI and HICP), industrial production, and unemployment. From Germany in particular, a key piece of data is the IFO survey, which is a widely accepted indicator of business confidence. Also important are budget deficits of the separate countries, which according to the Stability and Growth Pact, must be kept below 3% of GDP. Countries also have targets for reducing their deficits further and failure to meet these targets will likely be detrimental to the Euro (as we observed Italy’s loosening of budget deficit guidelines).

Cross Rate Effect: The EUR/USD currency pair is sometimes impacted by movements in cross exchange rates (non-dollar exchange rates) such as the EUR/JPY. For example, the EUR/USD could fall (decline in EUR) as a result of significantly favourable news from Japan that filters through a falling EUR/JPY rate. Conversely, the USD/JPY may be declining due to a weak euro – and respectively a falling EUR/USD.

3-Month Euro Futures Contract (Euribor): The contract reflects market expectations on three-month EuroEuro deposits (Euribor) into the future. The difference between futures contracts on the three-month cash Eurodollar and on the EuroEuro deposit is an essential variable in determining EUR/USD expected rate.

Other Indicators: There is a strong negative correlation between EUR/USD and USD/CHF, reflecting a steadily similar relationship between the Euro and the Swiss Franc. This is because the Swiss economy is largely affected by the Eurozone economies. In most cases, a spike (dip) in EUR/USD is accompanied by a dip (spike) in EUR/CHF. The inverse also usually holds. This relationship sometimes fails to hold in the event of data or factors pertaining solely to either one of the currencies.

Political Factors: Similar to all exchange rates, the EUR/USD is susceptible to political instability such as a threat to coalition governments in France, Germany or Italy. Political or financial instability in Russia is also a red flag for the EUR/USD because of the substantial amount of German investments in Russia.


Note: Views expressed here are for education purposes only and are not the views of Deltastock or its employees. These views are not personal recommendations or investment advice. Any quotes of financial instruments displayed on this page are indicative only and do not reflect the current market situation. You may wish to seek independent advice before entering into transactions.