The Euro (EUR) is on track for a second weekly gain versus the US Dollar (USD), supported by expectations of a narrowing policy gap between the Fed and ECB. While political risks in France and Germany persist, the euro is expected to maintain its upward momentum over the next 6-12 months, MUFG's FX analysts Lee Hardman and Abdul-Ahad Lockhart report.

Political risks in France, Germany eye market attention

"The euro is on track for its second consecutive week of gains against the US dollar. It has helped to lift EUR/USD back up closer to the 1.1700-level as the US dollar has weakened broadly ahead of next week’s FOMC meeting. The euro is benefitting from market expectations that the policy divergence between the Fed and ECB will continue narrow going forward as the Fed keeps lowering rates back to neutral while the ECB has already arrived there, and is more likely to leave rates on hold now."

"Political risks in the euro-zone mainly in France have dampened the euro’s upward momentum in recent months. The French government still has to pass a budget for next year which has the potential to trigger a renewed flare up in political risk before year end, although we assume they will carry over the current budget and try again early next year if parliament fails to pass next year’s budget in time."

"Bloomberg is also reporting that political risks in Germany may attract some market attention today. The ruling coalition government’s pension bill will be voted on today with the final ballot in the Bundestag scheduled for around 12.30pm local time and result expected to be announced at around 1pm. It has been reported that there is a risk the bill could be rejected. While we remain wary of political risks in Europe, we do not expect them to derail our outlook for the euro to strengthen further against the US dollar over the next 6-12 months."