The European Union, and the smaller Eurozone, is a political and economic framework which was created to form a tight bond between the 27 member countries.
In the 1990s, Europeans decided that they could increase trade among one another by making it easier. One way to make trade easier was to use a uniform currency which would be accepted in all nations. No longer would a German have to trade Marks for the old French Franc to buy a case of wine; instead, all nations would use the Euro. Keep in mind that not all participants in the European Union are part of the Eurozone. Eurozone nations use the Euro whereas European Union members do not necessarily use the Euro.
Monetary policy is also set by the European Monetary Union through the European Central Bank. While this has created some problems from on-going fiscal concerns in some EU member countries, the ECB created an economic powerhouse in merging all these great nations together.
Eurozone Economic Stats
The Eurozone produced more than $16 trillion of goods and services in 2010, making it the largest economy in the world, even if it includes many different nations.
The EU economy is varied, with some countries specializing in machinery and capital goods (Germany) while others produce less-skilled products such as textiles and mined metals. Major imports include machinery, automobiles, airplanes, and industrial inputs like oil, chemicals, and raw materials.
Import sources are:
China
United States
Russia
Norway
Switzerland
Exports include machinery, automobiles, airplanes, plastics, and medical supplies.
Exporting destinations include:
United States
Russia
Switzerland
China
Turkey (which is growing quickly)
Wealth in the EU
EU Monetary Policy
The European Central Bank is the deciding factor in monetary policy for all nations which use the Euro. ECB President Jean-Claude Trichet, along with the executive board members, make up the seven member ECB Governing Councel.
The ECB has a unique charter that isn’t seen in other central banks because it has to manage monetary policy for many different countries, which may have their own differences in fiscal policy. The Maastricht Treaty requires that individual countries must:
• Maintain an inflation rate no higher than 1.5% more than the average of the three lowest inflation recording.
• Have a long term interest rate lower than the low inflation rates plus 2% per year.
• Realize a fiscal deficit of no more than 3% of GDP.
These stringent requirements may seem to be out of touch, and in some cases, impossible to reach. However, if the ECB is to maintain a quality currency that is respected in international commerce, it has to make sure that the goals of the nations which use the Euro are in line with one another. If each country behaves differently, then how can one monetary policy fit them all?
The European Central Bank uses internal operations to guide interest rate policy. In particular, the bank adjusts the “repo rate,” or the rate reserves from member central banks stored at the ECB gain interest.
The ECB earns the ability to use open market operations as well, buying and selling bonds and fixed income products from member nations to keep each country on course, and the Euro stable.
Finally, unlike the United States, the ECB may directly intervene to buy Euros on the forex market to increase its value. It may also sell Euros to reduce the value of the Euro. In keeping the Euro at an appropriate level, the European Union does not suffer from hefty trade imbalances which result from currency values that are too high or too low.
Economic Indicators and Fundamental Releases
Because there are many member nations in the Eurozone, there are far more economic releases as each country still reports their own, individual numbers. However, Germany, the largest economy of the EU, is by far the most important economy to the Euro’s value, and investors’ trading activities.
Employment – Employment reports from the German government dwarf those of other nations. Since Germany is a highly industrialized nation, growing employment indicates a future (positive) change in GDP, and economic activity.
German Industrial Production – Another German economic release, the GIP measures the change in goods produced in Germany. This report includes the total Euro value of manufacturing, and mining businesses, and had a direct effect on employment.
Consumer Price Index – The ECB releases a European-wide CPI measure to report the change in consumer level prices over time. A reading that comes in too high is bad for the Euro, as inflation is running rampant. A reading that is too low (negative) indicates recession, a lack of growth, and deflationary pressure.
Fiscal Policy – Fiscal policy from member nations is paramount to their inclusion in the Eurozone, and the Euro’s health. If a member nation does not meet the goal of a debt-to-GDP ratio of less than .6, and a deficit less than 3% of GDP, investors start to worry about the future of the Euro, and all the nations involved in this economic alliance.
Euro Movers
Interest Rates – The second largest reserve currency, the Euro is seen as a currency which can be used interchangeably with the US Dollar. Carry trades with the Euro are common, which present long run price moves.
Risk – The Euro is also considered a safe haven currency. Investors tend to swap between the Euro and US Dollar for their preferred currency for safe investments. The relationship in the EURUSD pair becomes more visible when one currency shows a significant change in economic activity.
International Investment – The European markets are a great place for multi-national companies to tap a broad investor base. Since Euros are popular as reserve currencies, investment services companies often look to service European based clients to raise funds for projects all around the European Union, Asia, and increasingly, Africa.
