Big rate hike won’t save euro as energy shock deepens By Reuters

By Tommy Wilkes and Dhara Ranasinghe

LONDON (Reuters) – The hit to the euro zone economy and its currency from a deepening energy crisis is so severe that more aggressive monetary tightening from the European Central Bank will do little to stop the euro’s slide.

The euro on Monday fell below $0.99 for the first time since late 2002 after Russia halted the supply of through the main pipeline to Europe, sending energy prices soaring and heightening fears about a supply crunch.

The weakening currency will be front and centre for the European Central Bank meeting on Thursday since a weak euro – down 13% in 2022 — could make already record-high inflation worse through more expensive imports.

Weak euro adds to ECB inflation headache https://fingfx.thomsonreuters.com/gfx/mkt/myvmnzggdpr/euro2.PNG

Some policymakers have said that the bank must pay more attention to the euro than in earlier periods of weakness, because gas is priced in dollars and a weak euro amplifies the effects of soaring energy costs.

Money markets price in an 80% chance of a supersized 75 basis point rate increase this week, but analysts think that would do little to help the currency.

“This big rate hike will do nothing to rescue the euro. A recession is ahead and geopolitical concerns are uncontrollable,” said Agnès Belaisch, a strategist at the Barings Investment Institute. “In fact, the odds are high that rising interest rates coincide with inflation and recession in 2023.”

Goldman Sachs (NYSE:) on Monday forecast the euro to weaken to $0.97 and remain there for the next six months because demand destruction, caused by the gas crisis, will lead to “a deeper and longer contraction.”

Capital Economics revised its forecast to $0.90 for next year – a 9% slump from current levels.

The euro has been inversely correlated with gas prices for months, meaning it tends to fall when energy prices rise. Gas prices have soared 255% in 2022 and on Monday jumped 30%.

RECESSION WATCH

The euro zone is almost certainly entering a recession, with business activity contracting for a second month in August.

The energy shock is taking a deep toll, while data suggests speculators have jacked up their bets against the currency.

Euro short positions are building https://fingfx.thomsonreuters.com/gfx/mkt/xmvjoallapr/euro1.PNG

UniCredit estimates that in the five years before the COVID-19 pandemic, the EU imported about 400 billion euros worth of oil and gas annually.

If oil prices held at $100 a barrel, the euro at parity and natural gas prices at 100 euros – five times higher than the last five years’ average — the cost would jump to 600 billion euros, or 6% of GDP, calculates UniCredit’s Erik Nielsen.

Economists and currency analysts reckon the economic pain will be even more severe than anticipated just a few months ago.

“The euro zone narrative is shifting. A few months…