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Commentary: What Spanish political unrest could mean for the dollar

People shout slogans against Spanish National Police during a gathering outside a National Police station, in Barcelona, Spain October 2, 2017.
Yves Herman | Reuters
People shout slogans against Spanish National Police during a gathering outside a National Police station, in Barcelona, Spain October 2, 2017.

The dollar is starting off the week on a positive footing, as political trouble in Europe sends the euro lower.

In Spain, the Catalan government held a referendum on independence from Spain. The Spanish government has ruled the vote unconstitutional, and the referendum was met with violence and resistance by the Spanish national police. But Catalan leadership claims that it passed with 89.9 percent of the vote, and say they intend to formally declare secession within a week.

The Spanish cabinet is meeting to respond to the crisis, but given the bad feelings on both sides, compromise seems unlikely at this point. Catalonia is one of Spain's most productive regions, responsible for 20 percent of the GDP and 25 percent of the country's exports, and the standstill could greatly complicate the situation on the ground.

Spain has seen a strong rebound in economic activity from the financial crisis of 2008, but the political turmoil could scuttle the recovery — complicating policy action for the European Central Bank.

More broadly, the Catalan independence movement could inspire other fractures across the region, including in Italy, where separatist forces have been gaining ground as well.

One great unknown is the long-term impact of these events on the euro itself. The currency is actually uniquely structured to accommodate such adjustments, as it allows for political autonomy while maintaining economic unity. There is no doubt that the Catalan government will want to remain in the euro, but the question is whether Spain will try to veto its entry.

If Catalonia, as an independent entity, remains within the euro zone, the economic impact will be minimal as it will have to abide by the current European law. If, on the other hand, Madrid vetoes its entry the region will be left stranded, which will likely trigger a political crisis with the union itself, as this would challenge the very foundations of the euro zone ideal.

For now, the markets remained wary of risk, and the euro continued to slide throughout the night, hitting a low of 1.1730 in mid-morning dealing. If the crisis exacerbates as the week proceeds, the selloff could intensify as well, and the euro/dollar pair could break the key support levels at 1.1650 as the political calculus suddenly changes.

As a reminder, the euro makes up more than half of the basket of foreign currencies against which the greenback is measured in the dollar index.

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