European Union leaders are showing their resolve in keeping the euro region together, agreeing in an unannounced meeting on May 6 to review the terms of the 110 billion-euro ($158 billion) lifeline Greece received last year.
The euro tumbled 3.45 percent in the final two days of last week, the biggest back-to-back loss since 2008, as the European Central Bank signaled it is in no rush to raise interest rates and Der Spiegel magazine said Greece may withdraw from the currency bloc. EU officials denied the report and said Greece will need more aid. Standard & Poor’s reduced the nation’s credit rating by two levels today as investors drove yields on its two-year notes to more than 25 percent.
Even with last week’s decline, the single European currency was the year’s best performer through May 6 after German Chancellor Angela Merkel said Jan. 12 her country would do “whatever is needed to support the euro,” exports grew and the ECB raised borrowing costs for the first time since 2008. Bloomberg Correlation Weighted Indexes of 10 developed-nation currencies show the euro has gained 2.4 percent, compared with drops of 4.7 percent in the dollar and 4.2 percent in the yen.
Monetary union will survive “as long as the core economies remain strong,” Stuart Thomson, a Glasgow, Scotland-based money manager at Ignis Asset Management, which oversees about $120 billion, said in a May 7 phone interview. The meeting of finance ministers “shows their determination to support Greece. The move downward in the past few days has been very rapid, and we would expect it to get some support from here,” he said of the euro.
Euro Last Week
The euro fell 3.3 percent last week to $1.4316, while weakening 4 percent against the yen to 115.44 in the biggest weekly decline in a year. The shared currency was 1.3 percent lower versus the pound, fetching 87.49 pence, and dropped 1.8 percent against the Swiss franc to 1.2582. It traded at $1.4312, 115.39 yen, 87.55 pence and 1.2489 francs today.
French Finance Minister Christine Lagarde, who urged the EU in 2007 to weaken the currency when it was trading at the same level as now, said last week the euro is doing “extremely well” and its appreciation won’t hurt economic growth. Luxembourg Prime Minister Jean-Claude Juncker said the same on May 2, adding the currency’s appreciation is “not worrying.”
‘Vote of Confidence’
As Greek bonds tumbled in recent weeks, the euro rose to $1.4940 on May 4, the strongest since December 2009, before falling. The 17-nation currency has appreciated from last year’s low of $1.1877 in June, which EU leaders likely view as “a vote of confidence in the euro” and in their efforts to contain the region’s sovereign-debt crisis, Thomson said.
“From their perspective, the fact that business confidence in Germany and France remains strong is evidence of their ability to withstand the currency appreciation,” he said.
Europe’s parliament approved a permanent European Stability Mechanism in March to succeed last year’s 440 billion-euro, three-year European Financial Stability Facility created to assist the most-indebted countries.
While Greece, Ireland and Portugal have sought bailouts, the euro’s rally shows easing concern that the currency union will dissolve, a risk highlighted by former U.S. Federal Reserve Chairman Paul Volcker in a speech last May 13 in London and billionaire investor George Soros on Jan. 26 in Davos, Switzerland, at the World Economic Forum.
Euro Versus Dollar
The euro is up 9.7 percent against the dollar since Merkel’s January comments, which were endorsed by French President Nicolas Sarkozy. In Germany, Europe’s largest economy, business confidence rose to a record in February, according to the Munich-based Ifo institute.
Strategists are struggling to keep up with the euro’s gains. They raised their year-end estimate an average of 2.2 percent in April, the most for any Group of 10 currency, and the median forecast of $1.40 is still weaker than current market rate, according to data compiled by Bloomberg.
Der Spiegel reported, without saying how it got the information, that Greece is considering withdrawing from the euro and returning to its old currency. The Greek Finance Ministry denied any plan to leave the euro in an e-mailed statement.
The German Finance Ministry said reintroducing Greece’s old currency would lead to a devaluation that would boost the country’s outstanding debt by as much as 50 percent, Der Spiegel said, citing an internal study prepared at the ministry.
Greece Aid Speculation
Expanding the lifeline Greece received last year may mean that assets or revenue from asset sales will be required to obtain extra funds, said a person with direct knowledge of the May 6 meeting in Luxembourg, who declined to be identified because the talks are private. While demanding collateral may help avoid a political backlash against bailouts, it may not prevent a restructuring of Greek debt.
Greece’s credit rating was cut to B from BB- by S&P, which said further reductions are possible, with private investors at risk if maturities are extended on the nation’s emergency-aid package. Another rating cut would make Greece the lowest-rated country in Europe as today’s move left it even with Belarus after the fourth reduction by S&P since April 2010.
“We think that Greece does need a further adjustment program. This has to be discussed in detail,” Juncker said in Luxembourg last week, when European finance officials met for talks that included Greece.
“It does bring to the forefront the existential concerns about the euro,” Samarjit Shankar, a managing director for the foreign-exchange group in Boston at Bank of New York Mellon Corp., said in a telephone interview on May 6. “It underscores the risks that have never really gone away, but had gone to the back burner.”
Investors have driven yields on two-year Greek government notes above 25 percent from as low as 2.74 percent last year amid concern the nation’s leaders will require bondholders to accept losses as part of any restructuring.
Concern Greece will restructure its debt caused investors to demand an extra 12.33 percentage points in yield to own the nation’s 10-year notes rather than German bunds of similar maturity last week, according to data compiled by Bloomberg. The gap expanded from an average 2.73 percentage points in January 2010. The spread on Portuguese bonds widened to 6.39 percentage points from an average 0.87 percentage point.
Portugal announced on May 3 an agreement for a 78 billion-euro three-year loan package, which also gives the nation more time to reduce the budget deficit.
At the same time, concern is spreading that the region’s weaker economies won’t withstand higher interest rates, boosting chances the debt crisis will worsen and prompt the ECB to reverse last month’s increase in the refinancing rate to 1.25 percent from 1 percent.
That’s what happened in July 2008, when the ECB raised borrowing costs to 4.25 percent as the Fed was cutting the target rate for overnight loans between banks. European policy makers were forced to change course after Lehman Brothers Holdings Inc.’s collapse in September sparked the worst global financial crisis since World War II.
After that, the euro slumped 9.8 percent between July 2008 and May 2009 as the ECB cut the rate to 1 percent.
The currency may have risen too fast, making it vulnerable as the Fed ends its $600 billion bond-purchase program known as quantitative easing in June, said David Bloom, London-based global head of currency strategy at HSBC Holdings Plc.
“The euro is a bit overdone,” Bloom said. “It’s still very possible that the dollar can come back” this year and push the common currency down to $1.40, he said by phone last week.
When the euro approached $1.50 in October 2007, Lagarde said finance ministers should discuss selling the currency to keep the advance from hurting exports. As the shared currency climbed to an all-time high of $1.6038 in July 2008, European manufacturing was contracting and exports weakening.
Now, factory output and exports are surging. A Markit Economics gauge of manufacturing rose to a 59 in February, the highest level since June 2000, from 47.4 in July 2008 and the low of 33.5 in February 2009. Exports increased 1.6 percent in February to a record, with goods and services shipped to the U.S. jumping 30 percent in January, according to Eurostat. Germany’s sales abroad surged in March to the highest monthly value ever recorded, a government report showed today.
The economy likely expanded 2.2 percent in the first quarter, according to the median estimate of analysts surveyed by Bloomberg. That compares with 1.8 percent growth in the U.S. in the period.
The euro is doing “extremely well,” Lagarde said in a Bloomberg Television interview on May 4, adding that “you certainly get more value out” of a stronger euro when prices of commodities such as oil are rising. Juncker said last week in Tallinn, Estonia, the currency’s strength won’t hinder growth in the region.
Europe’s politicians may be supporting a stronger currency to help contain inflation by making the cost of imported goods cheaper and lessening the pressure on ECB President Jean-Claude Trichet to raise rates.
Inflation in the 17-nation euro region accelerated to the fastest pace in 2 1/2 years in April, reaching 2.8 percent, according to the EU’s statistics office in Luxembourg. Gains in consumer prices have exceeded the ECB’s 2 percent limit each month since last year.
“The ECB will stay hawkish because inflation is very ugly” in the euro area, said Christoph Kind, head of asset allocation at Frankfurt-based Frankfurt Trust, which manages $24 billion. “A strong currency is quite good in times of rising commodity prices, so the common attitude is to tolerate an appreciating euro.”
Hedge funds and other large speculators held a net 99,516 contracts at the Chicago Mercantile Exchange as of May 3 betting on a gain in the euro, the most since July 2007, according to the Washington-based Commodity Futures Trading Commission. As recently as January, there was a net euro short position.
“In a world where you have inflationary pressure it is desirable to get a stronger currency,” said Pierre Lequeux, London-based head of currency management at Aviva Investors, which manages about $370 billion.