Will the Euro fall to parity with the US dollar?
As the global financial crisis eases, the most significant aftershocks have been focussed on European markets, with the euro feeling the brunt of investor doubt – recently dropping to a four-year low of $1.2142 against the dollar.
As Warren Buffett once said, 'you only find out who is swimming naked when the tide goes out'. And as far as some economic onlookers are concerned, the swimmers left in the cold this time round are the debt-laden EU nations.
We discuss the view that Europe’s single currency looks set to reach parity with the US dollar.
Sovereign debt levels
This huge burden of national debt is the most significant factor sending the euro on its downward trajectory. While a bail-out fund agreed by the IMF and Europe’s finance ministers has gone some way towards plugging the black hole in Greece’s budget, there are now rising concerns over the ability of countries such as Spain, Portugal and Italy to contain mounting debt with appropriate austerity measures.
The takeover of beleaguered Spanish lender CajaSur at the weekend is a symptom of Europe’s economic fragility rather than a significant body blow to the region in itself. Nevertheless, the move has prompted further speculation over the ill health of Spain’s banking sector, thereby contributing to bearishness towards the euro. On the Monday after the takeover the euro fell 1.2% to $1.2396.
Meanwhile, there are wider fears that political pressure on national governments will prevent them from implementing deeply unpopular (but economically necessary) cuts. Vociferous opposition from Spanish unions and rioting on the streets of Athens certainly testify to such concerns and do little to settle jittery currency markets.
Short-selling ban
While a recent German ban on the short selling of European government bonds and some of Germany’s financial stocks may protect these markets from speculators, it also pushes the euro even further into the line of fire by making it the default market for expressing doubt about Europe’s potential for growth.
ECB intervention
Indeed, speculative trades against the euro have reached fever pitch, raising the prospect of an official intervention by the European Central Bank to protect the currency. However, there are compelling arguments against an intervention, not least the fact that a comparatively weak euro may in fact help Europe by making exports cheaper and bringing in increased tourism revenues.
That said, even the hint of an intervention by the ECB could – at least in the short-term – see the abundance of short euro positions snap as stop loss levels are activated. Consensus opinion, however, is still that a short position on the euro is a sensible bet given current economic fundamentals.
Dollar and sterling strengthen
Meanwhile, adding to pressure on the euro is the fact that the economy in the US seems to be in considerably better shape than in Europe, suggesting that the Fed will be in a position to increase interest rates well before the ECB is realistically able to do so. A strengthening dollar would, of course, continue the movement towards parity between these two key currencies.
To a lesser, but nevertheless significant degree, the Tory-Lib Dem coalition’s cost-cutting measures may help sterling strengthen against the euro.
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Updated: 25/05/10