Euro overshoot will rekindle tensions throughout the currency bloc

Whoever wins the “war” eventually, few doubt the euro area has been routed in the latest monetary battles between countries printing and depressing home currencies in part to retain trade advantage in a growth-sapped world.

Japan's plan to aggressively weaken the yen has been the most recent salvo. But that merely counters open-ended bond buying and dollar creation by the U.S. Federal Reserve, pound printing in Britain or even Swiss intervention to cap the franc.

It leaves the European Central Bank as the only operator of the “Big Four” reserve currencies still unable or unwilling to create new cash and put a lid on its exchange rate over time.

That fact was underlined last month by early paybacks on what had been the ECB's proxy printing plan of cheap long-term loans to euro banks (or LTROs) — repayments which have lead to an untimely shrinkage of the ECB balance sheet as its economy shrinks, creeping short-term interest rates and a rising euro.

The euro has now soared 20 percent against Japan's yen in just three months, 8 percent on sterling and 7 percent on the dollar — the latter compounding gains against a host of dollar-pegged, emerging currencies.

ECB chief Mario Draghi pointed out last month that the euro's trade-weighted index has been better behaved and still down more than 10 percent from 2009 peaks.

Yet this euro index too has rebounded 6 percent since November and is up almost 9 percent since Draghi's “whatever it takes” speech in July defused the bloc's sovereign debt crisis.

Morgan Stanley economist Elga Bartsch said there is a risk of the euro “overshooting” and derailing the zone's tentative stabilization by sapping exports, capital expenditure and corporate profits.

An irony of course is the euro's rebound is partly due to the healing of the bloc's crisis since July and the return of investors to peripheral bond and equity markets.

But for all that relief, an expected contraction of the bloc's economy for the second year running in 2013 means it's also the area least able to absorb a currency hit right now.

Morgan Stanley's “ready reckoner” shows a permanent 10 percent euro index rise could shave 0.5 percentage points off growth over the next year and sink its forecast for a 0.5 percent drop in growth in 2013 to a loss of almost 1.0 percent.

Enter anxious leaders. Calling for a medium-term euro exchange rate target to guide policy, French President Francois Hollande on Tuesday warned of 'irrational' currency moves at odds with the underlying economy.

But with little clarity yet on what that would involve, many look to Draghi to ride to the rescue yet again and hope for some hint of future interest rate cuts after Thursday's ECB meeting.

Yet short of dramatic change to either the central bank's mandate or inflation forecasts, few are holding their breath.

At best, ING economist Carsten Brzeski reckons the euro jump “put its foot into an almost closed door towards a rate cut.”

In the meantime, the threat of extreme appreciation returns us to the one-size-fits-all conundrum at the heart of the euro blowout over the past three years.

For example, Morgan Stanley's estimate of euro/dollar “fair value” — gleaned from relative inflation, growth, exports and labor costs — is US$1.33 and only just below current levels.

But that masks huge gaps between “fair value” assumptions for each euro member — stretching from US$1.53 for Germany to US$1.26 for Spain, US$1.19 for Italy and as low as US$1.07 for Greece.

And it highlights the daunting task facing the weakest euro members absorbing an exchange rate squeeze after years of back-breaking wage and fiscal adjustments to recoup competitiveness.

1|2|Next Page>>

SHARE CLOSE
Blogger		Google+
Live Journal		Plurk
Stumble Upon

Tweet

	PREVIOUS ARTICLE
	US challenges India over solar restrictions at WTO

NEXT ARTICLE
Sony set to announce new PlayStation: reports

Write a Comment

Terms

Enter your comments - 3000 characters max

Type in image code

 Receive China Post promos
 Respond to this email

Submit