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The Catalan Election and What it Could Mean For the Euro - Strategists Answer

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The Euro dipped following elections in Catalonia, but how much of a risk is the result to the stability of the Eurozone and the single currency in the longer-term?

The Euro weakened Friday despite better economic data from Germany and France. The explanation could be the resurgence of political risk as a result of the Catalan elections on Thursday night returning an inconvenient result.

Top of the table, with 48% of all votes was the pro-unity Ciutadans party, but pro-independence candidates laid claim to a majority of seats when all are thrown in together.

Separatists have taken an overall majority of 70 out of 135 seats in the Catalan regional parliament, which has brought the issue of Catalan independence back to the fore in Spain and Europe as a whole.

Most analysts have played down the negative implications of the election result for the Euro as being only a temporary phenomenon.

"Although political uncertainty in Spain has the ability to punish the Euro short-term, losses are likely to be limited by the growing optimism over Europe’s economic recovery," says Lukman Otunuga, an analyst at FXTM.

According to London Capital Group (LCG), the Euro reacted much more sensitively to the news this time than it did when Catalonia held its (unlawful) independence referendum back in October.

In October the Spanish stock market index, the IBEX, fell while the Euro was left unaffected. LCG contrasts this with the reaction Friday, which saw both fall.

Does this suggest the Euro is more at risk from Catalan separatism than previously thought?

"The euro is pricing in further political risk between the Spanish Government and the Catalan regional government, which potentially comes at a time when political risk in Germany could also become a bigger concern, given that the political vacuum there still hasn’t been filled," says Jasper Lawler, head of research at LCG, in a note Friday.

Richard Kelly, head of research at TD Securities, does not think Madrid will be overly concerned about the result.

"Separatist parties have suggested they will follow more constructive strategies towards independence. The Spanish government’s invocation of Article 155 (direct rule of Catalonia) is now a tried and tested tactic. Madrid won’t be shy to do it again should the independence drive flare up again in the region," he writes Friday.

At best, the result will lead to constructive talks between Barcelona and Madrid; at worst it will lead to another separatist 'Bloody Sunday' with Spain having to bring out the 'heavies' to restore direct rule again.

The timeline form here is that on the fifth of January the results will be officially verified and then the parties will have 20-days to form a ruling government with a working majority.

Since no one party gained enough votes to claim an absolute majority, the government will be a coalition, which is expected to be comprised of JuntsxCat (separatist), ERC-CatSi (separatist) and the 'neutral' CatComu-Podem. There is a third, more radical separatist party but they are seen as unlikely to be included.

The main factor to have driven the Euro higher before Friday is the strong economic recovery in the Eurozone and these elections are unlikely to change that says, Kelly.

However, the Catalan risk will be compounded in the run-up to the Italian national elections, which look set for early March next year, but Kelly in unperturbed from his bullish view by any of this.

"We think the case for EUR appreciation remains untarnished over the medium-term," he says.

Accordingly, TD's Kelly advocates buying dips in EUR/USD, with 1.1715 providing a key 'pivot' for entry, and targeting a move above 1.1960.

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