The Euro is the official currency of 16 of the 27 member states in the European Union (EU), which means that it is a currency used by over 320 Million people. The history of the Euro is something that traders must be aware of in order to have a complete understanding of the fundamentals of the currency. There were two key factors that resulted in the eventual formation of the European Union, and therefore the Euro, which are important for traders to understand.
Europe had a history of conflict between the major powers for hundreds of years prior to World War II. Following World War II however, it was recognized that a drastic reordering of the political landscape was required, in order to finally put an end to any nationalistic rivalries once and for all.
In addition to this, following World War II, the power structure of the world had altered, which led to the replacement of the major European countries, who were once the superpowers of the world, with two new superpowers. The United States and The Soviet Union were now the unrivaled superpowers of the world. Due to this fact, the former world powers of Europe realized that joining together was the only way for Europe to have any relative influence on the world stage.
It was mainly due to these two factors that the European Coal and Steel Community (which later became known as the European Economic Community, the predecessor to the European Union) was founded in the 1950’s with the general goals of:
The most important event that followed however was the ratification of the Maastricht Treaty in the 1990’s. Before this event, the concept of a union between nations in Europe was mainly focused on removing trade barriers and promoting economic cooperation. But with the Maastricht treaty, member countries shifted from a straightforward economic collaboration, to the much more ambitious goal of political integration between member nations.
As a trader this is important due to the fact that this was where plans for the single currency were introduced, with the basic fundamentals of the Euro outlined. There were three steps summarized in the Maastricht treaty that had to be completed before the currency could be released and these were:
Free circulation of capital among member countries, the coordination of economic policies. Upon the introduction of the Euro, monetary policy would be set by the ECB (European Central Bank) and the member countries would be bound by this. Therefore, this meant that it was not possible to have countries with large differences in the rate of inflation and interest replace their currency with the Euro without undermining the credibility and fundamentals of the currency. Member countries were therefore required to keep inflation, interest rates, and debt below certain levels. Finally they were also required to maintain an exchange rate that was basically a banded peg, allowing their currency to fluctuate only within a narrow band.
In 1999 the European Central Bank was established and the eleven countries listed below began to use the Euro (in electronic format only). Spain, Portugal, Italy, Belgium, the Netherlands, Luxembourg, France, Germany, Austria, Ireland and Finland.
These countries formed what is known as the European Monetary Union, which is made up of countries who are members of the European Union, and use the Euro as their currency. Since then Greece, Cyprus, Malta, Slovakia and Slovenia adopted the Euro. Over 75% of the Euro zone’s GDP is accounted for by Germany, France, Italy, and Spain. Due to this fact economic data out of these countries has a tendency to move the Euro the most, so traders naturally pay most attention to these. Of all the economic numbers released in the Euro zone, the ones that affect the current account (trade flows) or interest rates (capital flows) will be those that have the greatest potential to move the currency. It is important to note that the economic climate in the United States vs. the Euro zone will vary at times, so the market, and therefore traders, may react differently to the same number out of the EU than they do out of the US.
Another important thing to understand about EU economic releases is that the European Central Bank has a different mandate to that of the Federal Reserve. The Federal Reserve has a dual mandate of both maximizing employment and maintaining price stability, while the ECB’s mandate is purely maintaining price stability. Bearing this in mind, the ECB is generally seen as being more hawkish than the Federal Reserve. The ECB is more likely to hold or raise interest rates when economic data show price increases, and less likely to cut interest rates as quickly as the Fed when growth in the Euro zone slows.