Currencies: Euro drops, recovers as reports say German Chancellor Angela Merkel will step down as party leader

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The European single currency was in the spotlight on Monday — dropping sharply, then recovering— after reports that German Chancellor Angela Merkel would not seek re-election as party leader after a crushing defeat suffered by her party in regional elections.

The euro EURUSD, -0.0789%  initially dropped to $1.1360 before recovering to trade about where it left off in New York on Friday at $1.1403. The euro is looking at a loss of 1.7% for October, having seen pressure over the month from concerns about Italy’s budget worries.

The Wall Street Journal and other media outlets reported that Merkel will not seek re-election as the leader of the ruling Christian Democratic Union at an upcoming party conference in December, citing party sources. Merkel and her beleaguered government suffered a fresh blow after both her party and its coalition partner suffered hefty losses in Sunday’s election in Hesse, one of Germany’s wealthiest states. Those parties also saw losses in an election in the state of Bavaria earlier in October.

After almost two decades in power, reports that she will step down is a “dramatic sign of her waning authority that will raise questions about her staying in power as chancellor,” said Jameel Ahmad, global head of currency strategy and market research at FXTM, in a note to clients.

“There is no guarantee that Merkel’s decision to leave will have any negative impact upon Europe or Germany, yet it does add an element of uncertainty which could hold back confidence in the euro in Q4,” said Joshua Mahony, market analyst at IG, in a note to clients.

He said given the dismal showing for recent elections, “a change is clearly needed to avoid any further slide in towards the political extremes. With the right wing, anti-immigrant AfD party gaining 13% of the vote, there is a clear need to reshape the CDU’s position as Merkel continues to be defined by response to the 2015 immigrant crisis.”

The euro drew some support after news that S&P Global Ratings left Italy’s sovereign credit rating at BBB, two notches above junk, though it changed the outlook from stable to negative. Investors had been concerned S&P would follow recent action by Moody’s Investors Service, which knocked down Italy’s credit rating by one notch, a single rung above sub-investment grade status.

Elsewhere, the U.S. dollar, as gauged by the ICE U.S. Dollar Index DXY, +0.03%  , which measures the greenback against six rivals but is particularly weighted against the euro, firmed 0.2% to 96.551.

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