Euro Falls as Worsening Energy Shock to Test ECB on Rates

(Bloomberg) — The intensifying energy crunch in Europe is putting further pressure on the euro after Russia shut off key gas taps, signaling a cold and difficult winter ahead for businesses and households.

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Key European nations led by Germany announced measures over the weekend to tackle a cost-of-living crisis and spiraling energy prices after Russian state gas producer Gazprom PJSC Friday said it would indefinitely halt supplies through a key pipeline to Western Europe.

The shared currency dropped as much as 0.5% Monday to 99.04 US cents. That was just above the 99.01 cent trough hit in August — the euro’s weakest since December 2002.

“The outlook is poor for Europe — it started to get choppy at the tail end of last week, and it is almost certainly going to get worse,” said Gordon Shannon, a portfolio manager at TwentyFour Asset Management LLP.

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The energy crisis has been deepening since Russia’s invasion of Ukraine pushed commodity prices sharply higher and damaged relations between the Kremlin and Europe. This was a significant factor pushing the euro to parity with the US dollar last month for the first time since 2002. The new strains on energy supplies ahead of the winter threaten to put a further drag on the regional economy at a time when soaring consumer prices are putting pressure on the European Central Bank to tighten monetary policy.

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“The ECB had only just started to catch up with the Fed in terms of hiking rates, but if we are going into a prolonged recession, I think this slows down their attempts,” Shannon said.

Lagarde’s Challenge

There are growing expectations for the ECB to raise rates by 75 basis points as soon as Thursday. The decision remains a challenging one as chief Christine Lagarde and her colleagues manage the twin problems of high inflation and an impending recession.

In a sign of the severity of the problem, Germany unveiled Sunday a relief plan worth about 65 billion euros ($65 billion) while Finland said it would stabilize the power market with a $10 billion program. Sweden on Saturday announced a $23 billion emergency backstop for its utilities as it seeks to head off a broader financial crisis.

Read More: Nordic Utilities Get $33 Billion Backstops as Power Markets Fray

Goldman Sachs analysts led by Kamakshya Trivedi, meanwhile, shifted down their forecasts for the euro to 97 cents over the next three months from 99 cents previously, they said in a note Friday before the various relief packages were announced. They also believe the euro will remain below parity with the dollar over a six-month period. Previously they forecast a recovery to 1.02 dollars per euro.

“While the euro area has made good progress in amassing gas storage for the coming winter, this has come at the cost of significant demand destruction via production cuts, and does not totally eliminate the risk of a more severe disruption over the winter,” they said in the note.

(Updates euro’s move, Goldman Sachs targets.)