CFA franc zone: France’s election outcome reduces currency risk
As expected, France’s far-right leader, Marine Le Pen, was defeated at the second-round presidential election held on 7 May 2017, virtually eliminating the risk of a Frexit.
The outcome of France’s election, which saw EU-sceptic Le Pen obtain 34% of the vote against 66% for the social liberal president-elect Emmanuel Macron, has curbed populism in the EU, subsequently reducing uncertainty over the EUR and helping to calm world markets.
Le Pen had campaigned to adopt anti-business reforms (i.e. remove France from the eurozone, impose protectionist measures and curb immigration), while Macron had pledged pro-business reforms, which suggests that his victory will improve sentiment over the EUR and hence XOF/XAF.
This sentiment will also be supported by the inability of the Dutch Eurosceptic Party for Freedom (PVV) to gain significant traction in the country’s March 2017 elections and our expectation that Germany’s elections, scheduled for September 2017, will not present any significant risk to the EUR.
Already, following the immediate outcome of France’s election, the EUR traded at a high of 1.1021, before retreating to 1.093. Yields on France’s 10-year bonds also dropped further, while the French-German 10-year bond is at 0.42% which is lower than the long term average of 0.77%.
Macron’s election victory is likely to see the EUR:USD trade in higher ranges than that seen earlier in the year,
with the ECB potentially moving into a slightly hawkish tone on policy rates in the coming months.
However, while the risk from populism effect on the EUR has been contained, recent gains to the EUR will
be offset somewhat by the prospect of further monetary policy tightening by the US Federal Reserve Bank
and continued weak fundamentals in the eurozone (large fiscal and debt burden and subdued growth).
Although growth within the eurozone has picked up somewhat (registering 0.5% q/q in Q1 2017, up from
0.3% q/q in Q2 2016), domestic activity remains subdued. Similarly, core inflation, which is usually used to
guide monetary policy, remains tame (albeit climbing above 1.0% y/y in April 2017 for the first time since
September 2013) reflecting ongoing spare capacity in the labour market. This will ensure the ECB’s accommodative
monetary policy stance in the near term, although we envisage QE tapering by year end/early 2018.
On balance, we expect the EUR:USD to trade within a higher range bound of 1.070-1.12, compared with our
earlier range of 1.04-1.10. This will translate to a reduced rate of weakening in the XOF/XAF. EUR:USD volatility
(and hence XOF/XAF volatility) will persist owing to risk-off, risk-on sentiment over US’ fiscal policy
development, US’ payroll data and uncertainty over Macron’s party’s ability (En Marche), to secure majority
seat in the June 2017 parliamentary election and implement his policy proposals.
Meanwhile, despite improved EUR (XOF/XAF) outlook, we expect the regional central banks of the CFA franc
zone to maintain the exchange rate peg to the euro for the foreseeable future.
Although FX reserves held jointly by each of the two regional central banks in the CFAF zone and the French
Treasury (on the behalf of the ECB) have dwindled since 2013, they remain modest; moreover, CEMAC’s
regional central bank rejected a devaluation of the XAF at an extraordinary monetary policy meeting held
in December 2016 signalling its belief that the benefits of the peg still outweigh the costs. EU demand for the
region’s exports remains subdued, negating any benefit of a currency devaluation. In addition, improved
commodity price outlook and increased IMF intervention in UEMOA/CEMAC will provide some respite to
external and fiscal pressures.
For these reasons, we believe that the pegged exchange rate regime in UEMOA and CEMAC will continue
for the foreseeable future, although it cannot be guaranteed.
This ‘Speed Note’ was originally published by Ecobank. Read the original document here.