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Strong euro shows limits of ECB’s power in tackling deflation

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The strength of the euro is a sign that the European Central Bank is not doing enough to pump up stubbornly low inflation, investors say, highlighting how a rising currency could become an increasingly heavy burden for policymakers.

Despite a small pullback in January, the euro stands almost 9 per cent stronger against the dollar now than it did a year ago. The euro’s strength is not merely a reflection of a weak US dollar: it has also gained against the pound and a host of emerging market currencies.

The rally poses a challenge to the ECB. It could hamper exporters at a delicate time for the region’s economic recovery from coronavirus. But it also highlights the limits of the central bank’s ability to meet its mandate. Not only has the eurozone experienced five consecutive months of falling prices, but long-term inflation expectations remain far below the ECB’s target of close to 2 per cent.

“Ordinarily you would see low inflation cause a currency to fall,” said Robin Brooks, chief economist at the Institute of International Finance. “But that’s only if markets expect the central bank to respond, and right now the ECB is not getting the memo.”

The ECB has unleashed unprecedented efforts to tackle the effects of coronavirus since March, including a €1.85tn programme of asset purchases. But despite the central bank’s success in taming a financial market crisis, these measures have failed to remedy the bloc’s chronic low inflation problem.

Line chart of $ per € showing Euro strengthens during pandemic as inflation remains stubbornly low

Sticky euro strength shows markets think the ECB will not cut interest rates again, or at least cannot cut them by much. Meanwhile, though bond purchases hold down long-term yields there is little scope to lower them further.

That means real yields — long-term interest rates adjusted for expected inflation — have not fallen during the pandemic, in contrast to a dramatic drop in the US. Relatively buoyant real yields make euro assets more attractive to investors, boosting the currency. Germany’s 10-year real yield, a reference for the euro area, currently trades at minus 1.6 per cent, roughly where it did a year ago. While they remain higher at just above minus 1 per cent, US 10-year real yields have plunged by almost a whole percentage point over the same period.

The relationship between currency strength and deflation can become mutually reinforcing, as a strong currency chips away at import prices, muffling inflation. Mr Brooks likens the ECB’s predicament to that of the Bank of Japan in the wake of the financial crisis, when a disinflationary outlook boosted the yen, in turn further fuelling fears of deflation. The only way to break this vicious cycle is with much more aggressive monetary easing, with even larger asset purchases the best tool, according to Mr Brooks.

The ECB’s problem is that it has been left behind by more aggressive central banks — notably the Federal Reserve, which has slashed interest rates and bought up bonds at an even faster pace.

Line chart of 5y5y forward inflation swaps (%) showing Inflation expectations rebound faster in US than eurozone

“In currencies it’s the relative game that matters,” said Salman Ahmed, global head of macro at Fidelity International. “You can argue that the ECB has been very aggressive in its policy, but has it been more aggressive than others. If the ECB wants to get the euro down, they will have to outgun the Fed — there’s no other way.”

Mr Ahmed said the ECB could further tame the euro by dropping hints at its meeting on Thursday that cuts in interest rates are a possibility.

ECB officials have previously signalled their alarm at the euro’s strength, and it remains “extremely attentive” to the impact of the stronger euro on inflation, president Christine Lagarde said last week. More than half of the 33 economists polled by the FT last month said they expected the euro to continue rising against the dollar this year, while most of the others said they expected it to stay at current levels. Only two expect it to fall.

But if it wants to shift market expectations for future price rises, the central bank will have a job on its hands, fund managers say.

“The inflation trajectory remains bleak,” said Konstantin Veit, a portfolio manager at Pimco. According to its own projections, the ECB is set to miss its target by some distance for the next three years, raising the possibility of a “Japanese style de-anchoring of inflation expectations in the euro area,” he added.

Some analysts say the level of the euro — particularly given its more than 1 per cent January dip — is not yet sufficiently high to set alarm bells ringing in Frankfurt.

“The view from the ECB will be that a stronger currency is overwhelmingly the product of a rebound in growth expectations,” said Frederik Ducrozet, an economist at Pictet Wealth Management. “If we get to $1.30, that’s a different story, but I think they’ll be comfortable where they are.”

The common currency traded just below $1.21 on Monday.

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For many investors the ECB’s apparent powerlessness to bring down real interest rates or bond yields is a green light for further currency appreciation, particularly in a world where most analysts are expecting further dollar weakness as growth stirs in the US. There is considerable scepticism in markets about whether more aggressive ECB easing would make much impact on inflation expectations, given previous rounds have done little to shift them higher.

Even so, further currency strength could force the ECB to give it a try.

“With the euro, we are talking about a currency that’s becoming a deflationary currency,” said Mr Ahmed. “And we are close to the level where this is becoming painful.”

Additional reporting by Martin Arnold



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Europe

Marine Le Pen falls short in French regional vote

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Marine Le Pen’s far-right Rassemblement National party fell short of expectations in the first round of France’s regional elections on Sunday, leaving the Les Républicains party and other centre-right politicians in a strong position for the second and final set of ballots next weekend. 

The relatively poor results for the anti-immigration RN — in a record low turnout of about 33 per cent — will also provide some comfort for Emmanuel Macron, who is expected to face Le Pen when he seeks re-election as president next year. 

Le Pen described the low turnout as a “civic disaster” that gave a false impression of the political situation. “If you want things to change, you must vote,” she said in a short speech as the results began to emerge.

Xavier Bertrand, the centre-right leader of the Hauts-de-France region in the north, was on course for re-election and received a boost to his own presidential ambitions, with early estimates from BFMTV after polls closed giving him 44 per cent of the vote, against 24.4 per cent for Le Pen’s RN. 

Recalling that the RN had been ahead in the region after the first round in 2015, Bertrand boasted in a speech of “breaking the jaws” of his far-right rivals in this year’s electoral battle. Le Pen had campaigned in the north and hoped to flip the region to her party in Sunday’s vote. 

Xavier Bertrand after casting his ballot © AFP via Getty Images

Early estimates suggested that Le Pen’s party might be within reach of a first-round lead in Provence-Alpes-Côte-d’Azur in the south. But even there the performance was less impressive than predicted by opinion polls, which had suggested the RN would take control of the region after the second round in the first such victory in its history. 

That now looks less easy to achieve for the RN, since other parties have in the past tended to unite in a so-called “republican front” in second-round votes to keep the extreme right from power.

Nationwide, centre-right lists were forecast to receive about 29 per cent of the votes cast in the first round, against 19 per cent for the RN, 16 per cent for the Socialist party, 13 per cent for the Greens and 11 per cent for Macron’s centrist La République en Marche party. 

Incumbent parties performed well, with LR politicians in the lead in the Grand Est region in the east, Auvergne-Rhône-Alpes in the south-east and Ile-de-France around Paris. The Socialists expected to hold Occitanie and Brittany in the west.

Gérald Darmanin, interior minister, said the record low turnout was “particularly worrying”, adding: “Our collective effort must be to mobilise the French for the second round.” 

The low turnout did not fulfil the fears of Macron’s ally François Bayrou by benefiting the extreme right or the extreme left, and may have been the result of voter weariness with politics and a desire to enjoy themselves after more than a year of the Covid-19 pandemic. 

“The French have their minds on other things completely,” Brice Teinturier of polling group Ipsos told a webinar last week. “We are coming out of the pandemic . . . and the outlook for the economy is getting much better.”



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Delta variant begins to spread, threatening EU’s Covid progress

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The Delta coronavirus variant that swept the UK has become dominant in Portugal and appeared in clusters across Germany, France and Spain, prompting European health officials to warn further action is needed to slow its spread. 

While the new strain, which first emerged in India, still only accounts for a fraction of the total coronavirus cases in mainland Europe, it is gaining ground, according to a Financial Times analysis of global genomic data from the virus tracking database Gisaid. It accounts for 96 per cent of sequenced Covid-19 infections in Portugal, more than 20 per cent in Italy and about 16 per cent in Belgium, the FT’s calculations show.

The small but rising number of cases have raised concerns that the Delta variant could halt the progress the EU has made over past the two months in bringing new infections and deaths down to their lowest level since at least the autumn. 

“We are in the process of crushing the virus and crushing the pandemic, and we must in no way let the Delta variant get the upper hand,” France’s health minister, Olivier Véran, told reporters at a Paris vaccination centre on Tuesday. 

Véran said that 2 per cent to 4 per cent of virus samples being analysed in France were showing as the Delta variant: “You might say this is still low but it is similar to the situation in the UK a few weeks ago.” The FT’s analysis of Gisaid’s data suggests this figure could be higher.

Chart showing that the Delta variant now accounts for more than half of sequenced cases in parts of the US, and is growing in prevalence across the country

In Portugal, community transmission of the variant has been detected in the greater Lisbon area, where more than 60 per cent of the country’s new coronavirus cases in the past week have been identified. Non-essential travel to and from the city has been banned in an effort to prevent the spike in cases spreading to the rest of the country.

Scientists across the continent are now looking to the UK — where Covid-19 cases have tripled in the past month and the Delta variant accounts for about 98 per cent of all new infections — for clues about what may happen next and which measures may need to be taken.

After official data showed the Delta variant appeared to increase the risk of hospitalisation by 2.2 times compared with the Alpha variant, the UK government this week imposed a one month delay to the removal of its remaining coronavirus restrictions.

“The decisions the UK makes to reopen life and society will serve as a laboratory for us in Europe,” said Bruno Lina, a virologist in Lyon who advises the French government and helps co-ordinate variant sequencing in the country.

Whether the clusters of Delta infections peppering the EU turn into bigger outbreaks will depend in part on how many people have been fully vaccinated, scientists said, as well as people’s behaviour now that many restrictions on life and business are being lifted.

Chart showing that there are signs that many states are now seeing a shrinking outbreak of the Alpha variant, and a growing one of Delta

Recent UK government research has highlighted the need to complete vaccination programmes as quickly as possible. According to data gathered by Public Health England, the first dose of a Covid-19 vaccine is generally less effective against the Delta variant than with the previous strains. Two doses increases protection against symptomatic infection with Delta from 33 per cent to 81 per cent. 

While in the UK about 46 per cent of the population has been fully immunised, vaccination rates in most countries in mainland Europe are hovering at between 20 per cent and 30 per cent. About 26 per cent of the population in France has been fully vaccinated.

French authorities are currently trying to contain an outbreak in the Landes region, near the Spanish border, where 125 cases of the Delta variant have been confirmed by genetic sequencing and another 130 are suspected, representing about 30 per cent of recent infections in the area. Clusters of the Delta variant have also been identified in recent weeks in the southern suburbs of Paris and an art school in Strasbourg. 

In each case health officials have responded with the same formula: increased contact tracing and a renewed push to vaccinate people in the affected areas.

“If we keep vaccination going at a good pace, and some non-pharmaceutical interventions like masks indoors, we can still repress the circulation of the virus this summer,” said Lina, the French virologist. “This variant will displace the other ones — we must keep that in mind — but it doesn’t mean that it will lead to a new epidemic wave.”

Vaccination site in Jutland, Denmark
Denmark has only identified a small number of Delta infections, even though the variant arrived in the country at approximately the same time as in the UK. © Henning Bagger/EPA-EFE

Some scientists fear the Delta variant may have already spread further but gone undetected given that less of the genomic sequencing needed to identify variants has been completed in mainland Europe. While the UK has sequenced more than 500,000 Sars-Cov-2 genomes, Germany, France and Spain have sequenced about 130,000, 47,000 and 34,000 respectively.

“It’s costly, it’s time consuming and it was neglected,” said Antoine Flahault, director of the Institute of Global Health at the University of Geneva.

Denmark, however, has sequenced a high proportion of cases and still only identified a small number of Delta infections, even though the variant arrived in the country at approximately the same time as in the UK.

This could be explained partly, experts said, by differences in demographics and movement, including the number of cases imported into the country from regions with a high prevalence, such as India, and the living conditions in the communities into which it is seeded.

The difference in the pace of Delta’s spread across European countries remained “a little bit of a mystery”, said Jeff Barrett, director of the Covid-19 Genomics Initiative at the Wellcome Sanger Institute in Cambridge.

Still, many experts believe that wherever the Delta variant is introduced, it will eventually become dominant. The key, they say, will be to increase the proportion of fully vaccinated people, while slowing transmission of the virus as much as possible.

“We have to keep the messaging very clear,” said Lina in Lyon. “This is not over.”

Additional reporting by Daniel Dombey, Peter Wise, Guy Chazan and Clive Cookson



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EU fails in legal bid to speed up AstraZeneca vaccine supply

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The EU has lost a legal bid to force AstraZeneca to speed up delivery of Covid-19 vaccines or risk billions of euros in fines, the latest round in a bitter battle between the bloc and the UK-Swedish pharmaceutical company.

In a ruling on Friday, a court in Brussels criticised AstraZeneca for a “serious breach” of its contract with the EU after repeated shortfalls but refused to impose a new schedule demanded by Brussels that would have required the company to deliver 120m doses by the end of June or pay fines of €10 per dose per day.

The dispute between the European Commission and AstraZeneca has severely damaged the company’s standing on the continent and in February spiralled into a diplomatic row when Brussels threatened to exercise an emergency provision of the Brexit deal to stop vaccines entering the UK via Northern Ireland.

The Brussels court ruled that AstraZeneca should provide 80m doses by the end of September. However, in practice this should have no impact on AstraZeneca, which has already delivered 70m doses and plans to provide the remaining 10m before the end of this month.

The commission insisted that the court judgment would nonetheless put pressure on AstraZeneca because it had “laid the tracks for the delivery of future doses on the basis of clear contractual principles”, including supply from British manufacturing sites.

“The company will have to follow these tracks and it can no longer argue that it cannot use the UK plants for the production of vaccines for the European Union,” the commission said.

The ruling found that the pharma company’s failure to send the EU vaccines manufactured in the UK was inconsistent with making the “best reasonable efforts” on supply required by its contract. But it did not order AstraZeneca to use UK production to fulfil the EU order.

A UK plant operated by Oxford BioMedica is nonetheless expected to start manufacturing for the EU, according to a person familiar with the matter. 

AstraZeneca was originally expected to supply up to 300m doses to the EU in the first six months of this year but that forecast was cut sharply after production problems.

With the pace of the EU’s vaccine rollout improving, using mainly Pfizer/BioNTech and Moderna jabs, and some countries imposing restrictions on the AstraZeneca vaccine after the discovery of rare blood clots, there is less practical need for the doses.

Jeffrey Pott, AstraZeneca’s general counsel, said: “AstraZeneca has fully complied with its agreement with the European Commission and we will continue to focus on the urgent task of supplying an effective vaccine, which we are delivering at no profit to help protect people in Europe and around the world from the deadliest pandemic in a generation.”

Ursula von der Leyen, president of the commission, said: “This decision confirms the position of the commission: AstraZeneca did not live up to the commitments it made in the contract. It is good to see that an independent judge confirms this.”

The court is due to hold hearings in September on a second case brought by the Commission seeking judgment on whether AstraZeneca failed in its duty to deliver on the supply contract. 



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