Euro Struggles to Reverse Slump After Draghi's Dovish Message to EU Parliament

The euro extended declines against the U.S. dollar Monday as investors trimmed holdings of the single currency after dovish testimony from European Central Bank President Mario Draghi to lawmakers in Brussels and concern that Germany may face fresh elections in the new year.

Speaking as part of his regular appearances before the Economic and Monetary Affairs Committee of the European Parliament, Draghi repeated his view that consumer prices in the currency area remain tepid and haven't translated into faster wage growth despite an improving labor market and solid economic growth. He also indicated that the Bank's €2.4 trillion ($2.8 trillion) quantitative easing program was "flexible enough" to  be adapted if geopolitical risks were to cause tighter financial conditions in the Eurozone.

"Despite the firm economic recovery, inflation dynamics have yet to show convincing signs of a self-sustained upward trend. Headline inflation was 1.4% in October and is expected to temporarily decline towards the turn of the year, mainly owing to a weaker energy component as a result of base effects," Draghi said. "Underlying inflation pressures are still subdued as labour market slack remains significant. The improvements in labour markets that we have observed still need time to translate into more dynamic wage growth."

Translation: if the ECB needs to ease again in 2018, another QE extension at an even slower pace would push rate hikes expectations further out. https://t.co/jsbJaeuXeu

— Frederik Ducrozet (@fwred) November 20, 2017

The euro was marked 0.37% lower against the dollar at 1.1747 by late afternoon in Frankfurt, with pressure also coming from the collapse of coalition government talks in Germany where Chancellor Angela Merkel may need to seek permission from President Frank-Walter Steinmeier for fresh elections in the new year.

Merkel's fourth-term as Chancellor is now is jeopardy, as is indeed the fate of parliament in Europe's biggest economy, as she will either have to form a minority government with the Greens or ask the President to call fresh elections in the new year - both of which haven't happened since the Second World War.

"It is a day of deep reflection on how to go forward in Germany," Merkel lamented to the German media even as she indicated she would stay on as Chancellor. "I will do everything to ensure that this country is well managed in the difficult weeks to come."

The lack of government clarity in Berlin, which generally drives decision-making in the broader European Union, comes at an exceedingly sensitive time for the bloc, which is not only negotiating exit terms for the United Kingdom but is also bracing for national elections in Italy, its third-largest economy, that could see significant gains for the anti-European 'Five Star Movement' party and its firebrand leader, Beppe Grillo.

It could also delay, or possibly derail, the reform agenda championed by new French President Emmanuel Macron, just as the region's economic recovery is kicking in to full swing.

New estimates from the European Commission suggest the economy is set to grow at its fastest pace in a decade, with collective GDP growth for the 19 countries that use the single currency expanding at a 2.2% clip this year -- well ahead of its Spring estimate of 1.7% -- and 2.1% in 2018. The region's executive branch also said it expects to see France and Spain to cut budgets deficits deeply enough to align with EU rules and sees Italy's debt-to-GDP ratio peaking at 132.1% this year.

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