Any peace deal in Ukraine would benefit the euro?

Why the big difference? The short answer is that the euro zone suffered a massive deterioration in its terms of trade (the ratio of export prices to import prices) on account of the huge surge in gas prices when Russia started its assault. The region will not experience a similarly-sized improvement in its terms of trade if President Trump manages to cajole Russia and Ukraine into a peace deal.

To see this, consider that natural gas prices in Europe averaged somewhere in the region of EUR25 per MWh in the two decades before the pandemic. Prices moved up through 2021, partly as a function of the pandemic but also seemingly due to the Russian troop build-up on the Ukrainian border. But it was in February 2022 when the Russian invasion was launched that natural gas prices really surged in Europe given that around 45% of Europe’s gas was being supplied by Russia. Prices rose to a peak of around EUR350 per MWh.

As Europe re-routed its energy requirements elsewhere to other countries, such as Norway, and other commodities (LNG) so gas prices retreated and they currently stand close to EUR60 per MWh, or roughly two-and-a-half times the pre-war average. A peace deal might, conceivably, push prices back to their average pre-war level but that probably depends on Russia being able to route gas supplies to Europe through Ukraine again. These are currently shut off but re-opening could clearly be part of any peace deal. This would represent a positive terms of trade shock for the euro zone and conceivably aid the euro against the dollar and other currencies.

However, a halving of European natural gas prices on a peace deal would be tiny relative to the 10-fold-plus rise in European gas prices that we saw soon after the conflict started in 2022. The scale of this negative terms of trade shock in 2022 pushed euro/dollar down by around 15% in the six-months, or so, following Russia’s invasion in February 2022. A positive terms of trade shock now, if peace were to break out, should theoretically at least only see a tiny fraction of the 2022 decline reversed.

A second issue is the impact on monetary policy. For while the war in Ukraine has shifted European gas prices around dramatically; the impact in the US natural gas market has been far smaller. Assuming this continues in the aftermath of any peace agreement, it would likely suggest a steeper fall in European gas prices compared to those in the US. Hence, if any central bank takes advantage with lower rates it would be the ECB. But the cost of this could be downside pressure on the euro as rate differentials move against the single currency. 

A third factor to mention is that it appears that both the EU and Ukraine could be bystanders in a peace deal that’s largely brokered between the US and Russia, and that tends to suggest that any deal might not work out so well for both. Ukraine could, for instance, have concerns about its future security while the EU would most likely be forced to pay for much of the reconstruction if, as seems very possible, Russia’s frozen reserves are handed back as a result of the US/Russian peace deal.

In short, while any peace would undoubtedly be welcome and so prove a positive benefit for the euro, it could be counterbalanced by the sort of peace deal that is agreed. A deal that’s very much governed by the interests of the US and Russia can hardly be one that acts as a natural support for the euro.

“We are very cautious about how much support a peace deal between Russia and Ukraine could give the euro. As mentioned earlier, the euro fell some 15% against the dollar in the six months after war broke out in 2022. If peace breaks out soon we’d be surprised to see the euro recover more than a third of that loss over a similar period”, said Steven Barrow, Head of Standard Bank G10 Strategy.