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Euro Continues to Ignore Catalan Crisis, But For How Long?

Euro Continues to Ignore Catalan Crisis, But For How Long?

Martin Essex, MSTA, Analyst

Talking Points

- One striking fact about the independence row between Catalonia and Spain is that so far only Spanish stocks and bonds have suffered.

- However, the Euro could yet be drawn in if the ECB decides to take a cautious approach to tightening monetary policy because of heightened political risk.

What Does the Fourth Quarter Hold for the Euro, Equities, Oil and Other Key Markets? Find out here

Spanish stock prices have suffered and Spanish sovereign bond yields have risen as the ongoing dispute between Catalonia and Spain over independence for the region continues. However, the Euro and other continental European stock markets have largely ignored the spat, which has been seen so far as a domestic Spanish issue.

That inevitably raises the question of whether contagion could yet spread, both to the currency and to stock markets in countries like France, which borders the Catalan region. One possible scenario is that the European Central Bank, which is widely expected to tighten monetary policy early next year, decides that to do so at a time of heightened political tensions in one of the Euro-Zone’s largest economies would be unwise – and a change of heart at the ECB would certainly hit the Euro.

As the chart below shows, EUR/USD began to ease a month ago but has stabilized over the last couple of weeks.

Chart: EUR/USD Daily Timeframe (May 18 to October 10, 2017)

Euro Continues to Ignore Catalan Crisis, But For How Long?

Chart by IG

That contrasts with the performance of the Spanish government bond market, where the yield on the benchmark 10-year issue jumped from just over 1.4% to a peak of 1.81% earlier this month before easing back to the latest 1.66%. Similarly, Spanish stocks have been declining steadily at a time when Germany’s DAX has reached record highs.

Chart: IBEX 35 Spanish Stock-Market Index Daily Timeframe (April 24 – October 10, 2017)

Euro Continues to Ignore Catalan Crisis, But For How Long?

Chart by IG

A change of heart by the ECB might be a low-probability outcome but it is certainly not impossible, particularly if Catalan President Carles Puigdemont makes a unilateral declaration of independence in a speech to the Catalan Parliament later Tuesday. That would follow the disputed referendum in which Catalonia voted for independence in a poll that was declared illegal.Armed police have been deployed outside Catalonias parliament building ahead of the speech.

In the meantime, the ECB’s Sabine Lautenschläger gave the Euro a boost late Monday, saying the central bank should scale back its asset purchases next year before ending the program altogether. Her comments were in line with those of other German officials, who have generally taken a hawkish line on ECB monetary policy.

--- Written by Martin Essex, Analyst and Editor

To contact Martin, email him at martin.essex@ig.com

Follow Martin on Twitter @MartinSEssex

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