The European Central Bank’s policy of raising interest rates may not be “appropriate” and could drive the euro down 16 percent or more as the region’s fiscal crisis persists, according to Standard Life Investments.
The currency may weaken below its “fair value” of $1.20 to $1.25, said Ken Dickson, investment director for currencies at the Edinburgh-based company, which oversees about 157 billion pounds ($256 billion).
“The euro is a particularly risky currency at these levels because the increasingly restrictive policy and the financial conditions are not really appropriate,” Dickson said in an interview. A series of rate increases “is not appropriate for the conditions or economics of Europe as a whole,” he said.
Investment strategists at Standard Life, Aberdeen Asset Management Plc and Scottish Widows Investment Partnership said last month that the biggest risk to markets was the possibility of policy makers getting decisions wrong. While ECB President Jean-Claude Trichet said this month’s quarter-percentage-point increase in the main refinancing rate wasn’t necessarily the start of a series, colleagues signaled more are to come.
Ewald Nowotny, an ECB governing council member and governor of Austria’s central bank, told Bloomberg News in Washington on April 16 that investor expectations that the rate will rise an extra 50 basis points in 2011 are “well-founded.” Belgian counterpart Luc Coene said on April 17 that monetary “conditions are still too accommodative.”
Dickson said at his office on April 18 it was “feasible” the ECB may raise the cost of borrowing by more than is justified by the outlook for the economy and inflation, and then be forced to cut rates again.
The ECB in Frankfurt lifted its main rate to 1.25 percent on April 7, the first increase since July 2008, as it sought to contain an inflation rate that exceeded its 2 percent target.
The central bank is trying to balance the need for tighter policy in countries including Germany, whose economy is booming, against the risk of exacerbating the debt crisis afflicting Greece, Ireland and Portugal. Inflation accelerated to 2.7 percent in March, the fastest since October 2008.
The euro has declined 0.2 percent against its nine most- actively traded peers since April 7, trimming this year’s gains to 3.4 percent, Bloomberg Correlation-Weighted indexes show. The euro traded at $1.4507 as of 11:43 a.m. in London, up 8.3 percent against the dollar since Dec. 31.
Strategists in Scotland said at a discussion in Bloomberg’s Edinburgh office on March 23 that the timing of rate increases in developed economies, China’s accelerating inflation, the European debt crisis and the U.S. fiscal deficit all posed bigger threats to markets than higher oil prices.
“Our fear is that tightening policy, both from interest rates and through further appreciation in the euro is not the right economic formula for Europe at this time,” Dickson said. “We expect the euro to move to an undervalued position. It’s feasible that it could take longer than this year but we think the end of this year the clear direction of travel would be for the euro to weaken.”
Dickson advises Standard Life money managers on currency investments. The company boosted assets under management by 13 percent last year, while Aberdeen Asset Management Plc, the largest fund company in Scotland, increased its funds 27 percent to 183.3 billion pounds. Scottish Widows Investment Partnership lifted assets 3.2 percent to 146 billion pounds.
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