Factors Affecting EUR/USD

The Eurozone: The 11 countries that have adopted the euro in order of GDP: Germany,
France, Italy, Spain, Netherlands, Belgium, Austria, Finland, Portugal, Ireland and Luxembourg.
European Central Bank (ECB): Controls monetary policy for the eurozone. The decision
making body is the Governing Council, which consists of the Executive Board and the governors
of the national central banks. The Executive Board consists of the ECB President, Vice-
President, and four other members:
ECB President- Wim Duisenberg (Netherlands)
Vice President- Christian Noyer (France)
Board Member (Chief Economist)- Otmar Issing (Germany)
Board Member- Tomasso Padoa-Schioppa (Italy)
Board Member- Eugenio Domingo Solans (Spain)
Board Member- Sirkka Hamalainen (Finland)
ECB Policy Targets: The primary objective of the ECB is price stability. It has 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 very 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 to make announcements on interest
rates. At 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 the Bank s 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): The interest rate on 3-month Euribor, deposits held in banks
outside the Eurozone. It 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.
10-Year Government Bonds: Another important driver of the EUR/$ exchange rate is the
difference in interest rates between the US and eurozone. The German 10-year Bund is normally
used as the benchmark. Since the rate on the 10-year Bund is below that of the US 10-year note,
a narrowing of the spread (i.e. rise in Germany yields or fall in US yields or both) is theoretically
expected to favor the EUR/$ rate. A widening in the spread, will act against the exchange rate.
So the 10-year US-German spread is a good number to be aware of. The trend in this number is
usually more important than the absolute value. The interest rate differential, of course, is usually
related to the growth outlook of the US and eurozone, which is another fundamental driver of the
exchange rate.
Finance Ministers:
Germany: Hans Eichel, who took over when his more left-wing predecessor, Oskar Lafontaine,
resigned in March 1999.
France: Christian Sautter replaced Dominique Strauss-Khan who resigned in November 1999.
Italy: Finance Minister Vicenzo Visco, Treasury and Budget Minister Giuliano Amato.
Economic Data: The most important economic data is from Germany, the largest economy, and
from the euro-wide statistics, still in their infancy. The 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 watched indicator of business confidence. Also
important are the budget deficits of the individual 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 saw
with Italy s loosening of its budget deficit guidelines).
Cross Rate Effect: The EUR/USD exchange rate is sometimes impacted by movements in cross
exchange rates (non-dollar exchange rates) such as EUR/JPY or EUR/JPY. To illustrate:
EUR/USD could fall as a result of significantly positive news in Japan, that filters through a
falling EUR/JPY rate. Even though, USD/JPY may be declining, euro weakness spills onto a
falling EURUSD.
3-month Euro Futures Contract (Euribor): The contract reflects markets expectations on 3-
month euro-Euro deposits (euribor) into the future. The difference between futures contracts on
the 3-month cash eurodollar and on the euro-Euro deposit is an essential variable in determining
EUR/USD expectations.
Other Indicators: There is a strong negative correlation between EUR/USD and USD/CHF,
reflecting a steadily similar relation between the euro and the Swiss franc. This is because the
Swiss economy is largely dependent upon 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 of
the currencies.
Political Factors: As with all exchange rates, 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 EUR/USD, because of the substantial amount of
Germany investment directed to Russia