Euro parity is back on the dial for FX markets – Today

* Euro outlook deteriorates on high oil prices

* Don’t rule out a move to parity, analysts say

* Euro shed 3% in Q3, on track for 3rd year of losses

LONDON, Oct 4 (Reuters) – Resurgent oil prices hurting a
deteriorating economy and renewed concerns about Italy’s fiscal
position mean headwinds for the euro are getting stronger,
raising the risk of a move back towards the psychologically key
$1 marker.

The euro, trading at its lowest levels of this year
near$1.05, fell 3% versus the dollar in the third
quarter. It is poised for a third straight year of losses.

Much of this can be explained by a broadly firm dollar given
the U.S. economy’s resilience and cash sucked in from abroad as
10-year Treasury yields creep towards 5%.

Yet increasingly, euro area specific factors, particularly
exposure to higher oil prices, risk further weakness in an
already stagnating economy, and the single currency.

The euro is especially vulnerable to rising oil prices, with
net imports accounting for over 90% of oil products available in
the European Union.

“High oil prices are weighing on the euro area’s terms of
trade, and if oil prices move above $100 per barrel to $110 per
barrel we think it will be difficult for the euro to avoid
parity,” said Nomura’s G10 FX strategist Jordan Rochester.

Oil prices surged almost 30% in the last quarter alone,
nearing $98 last week, as oil producing group OPEC and its
allies squeeze crude supply.

Barclays, among other banks, expects oil to reach $100 in
the coming months.

Nomura now expects the euro to weaken to $1.02 by year-end,
which would imply a further 3% fall from current levels.

Morgan Stanley chief Europe economist Jens Eisenschmidt said
besides being more exposed to energy shocks, the euro area is
also more exposed to geopolitical risk than the United States.

This hurts the bloc’s competitiveness and dents the euro’s
longer-term prospects, the former European Central Bank
economist added.

Morgan Stanley did not expect a fall to parity, but still
expected a further weakening to $1.03.

A weak euro helps boost exporters’ competitiveness. But it
also lifts price pressures through higher import costs,
compounding the impact from higher oil prices. This suggests the
ECB may need to pay more attention although it doesn’t seem too
worried now.

On the trade-weighted index closely followed by the ECB, the
euro fell just 0.9% last quarter and is roughly 2% higher
compared to where it ended 2022.

When the euro hit parity against the dollar last year, for
the first time in 20 years, the ECB said it was watching the
currency because of its impact on inflation but did not target a
specific level.

ITALY WATCH

For ING currency strategist Francesco Pesole, another
warning sign is Italy. The closely-watched yield premium Italian
debt pays on top of Germany last week touched 200 basis points,
a threshold, he said, that normally coincides with a pick-up of
the correlation between that premium and the euro.

“Should we see a material deterioration in the Italian bond
market, and barring a swift reaction by the ECB to calm
investors, euro/dollar downside risks would extend to the
$1.00/$1.02 area,” said Pesole. He added that a backdrop of
solid U.S. data and a hawkish Federal Reserve was also
important.

For sure, euro weakness could be limited if the U.S. economy
slows along with inflation, which could take the shine off a
dollar at 10-month highs versus a basket of peers.

“If we have a combination of higher (U.S.) unemployment and
lower inflation, that’s negative for the dollar,” said
Athanasios Vamvakidis, global head of G10 FX strategy at Bank of
America.

But “you can see euro-dollar at parity if the U.S. economy
starts to weaken but inflation is sticky – though that is a risk
not our baseline,” he said.

The nearer-term outlook suggests other challenges for the
euro.

Investors have held bets on euro strength for some time and
latest positioning data shows a net long position worth $13
billion. A further unwind could exacerbate downward momentum.

And with the ECB signalling the end of its most aggressive
tightening cycle on record is likely over, the boost from higher
rates has faded.

Gilles Moec, chief economist at AXA Investment Managers,
said while the ECB’s September rate hike would usually have been
a euro positive, expectations for much weaker economic growth
dominated.

“Definitely the euro zone is not in a good place right now,”
said Moec, adding that he did not rule out a euro move to
parity.

(Reporting by Dhara Ranasinghe and Alun John in London and
Yoruk Bahceli in Amsterdam; Editing by Christina Fincher)