Eurozone could be set to CRASH: Expert warns ECB has fears over rapidly rising Euro

The exchange rate between the Euro and the US dollar has been tightening throughout the summer.

Writing in the Financial Times, Italian economist Lorenzo Bini Smagh said: “The European Central Bank seems to be increasingly concerned about the exchange rate of the euro, which has been rapidly appreciating against the US dollar over the summer. 

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“Rightly so, considering past experience.”

Currency tends to rise and fall in cycles lasting a period of years, but a fast appreciation could suggest a sudden downturn.

A similar cycle happened between 2005 and 2008, when the Euro’s value increased by a staggering 30 per cent after the US Federal Reserve inverted its policy and the ECB raised interest rates.

But when the Federal Reserve began to raise its interest rates and the ECB signalled a possible slowdown of its asset purchase programme, the exchange rate jumped by 10 cents in less than three months.

Mr Smagh said that history seems to be repeating itself, and its not hard to imagine the direction the Euro is going to move to.

He also said there are a number of indicators that the Euro could be set to appreciate faster than the last cycle.

In the previous scenario the Fed raised rates 17 times, slowly and gradually. Whereas rates have only been increased three times in the last two years.

Also, the Eurozone account is in surplus of about three per cent, while it was in balance in the mid-2000s. This creates a demand for an extra €350bn creating upward pressure on the currency.

After a two-year lag the Euro is poised to outperform the US in growth, and this current rapid rise in value of the single currency has the ECB worried for a number of reasons, according to Mr Smagh.

It could put a downward pressure on the rate of inflation making it difficult for the ECB to reach its goal of inflation below but close to two per cent.

Economic activity could slow down, leading the ECB to continue its accommodative policy measures for longer. This includes negative interest rates and government bonds purchase.

Mr Smaghi added: “A final problem is the inherent dynamics of the foreign exchange markets.

“As shown in the past, exchange rate movements tend to be unrelated to underlying fundamentals for quite a long time, as central banks are not fully equipped to counter self-fulfilling short-term markets developments.

“The ECB has good reason to be concerned.” 

Last week ECB policymakers agreed to reduce their bond purchases and possibly cutting asset buying. 

Analysts say a strong euro could have a negative impact on bank earnings, although that could be mitigated by a boost to their capital adequacy ratio; the amount of money a bank has in proportion to its liabilities.

Strength in the currency accompanied by strong economic growth is seen as positive.

On Friday, Eurozone finance ministers will launch a debate on the future of the single currency area that could lead to much deeper integration of their 19 economies and the creation of a euro zone finance minister and budget.

The discussions are part of a renewed drive, led by Germany and France, to revamp the bloc after it was rocked by the sovereign debt crisis and Brexit.

Berlin and Paris agree it would be a positive move to have a joint pool of money specifically for countries using the euro. This pool of money and budget would be run by a euro zone finance minister.