10/07/2003 15:45
Europeans may not like having a continually improving single currency but, as Corinne Lim writes, they have little choice.
Aturbo-charged euro will restore balance to an investment world too-long smitten with American dollars but it also has provoked strong criticism of the European Central Bank's management of interest rates.
The euro's vigorous rise early this year warranted deeper interest rate cuts from the ECB months ago but the bank, after a minimal 25 basis point cut in March, waited until June, jeopardising the 12-nation euro zone's economic recovery.
What irks many economists is that the euro's gains to date have already wiped out the growth-friendly effects of the ECB's rate cuts and may mean future cuts may not lift the weak economy off its knees this year.
Changes to monetary policy settings usually take a minimum of six to nine months to kick in, meaning embattled borrowers will not benefit from last month's 50 basis point rate cut to 2 per cent for some time. Strategists expect the slow-moving ECB to sit pat on rates at tomorrow's meeting but consider another cut in August or September.
The euro's upswing stumbled in the last three weeks and, at $US1.1320 yesterday, it was down almost 5 per cent from a mid-June peak. Last month's rate cut from the US Federal Reserve revived hopes for economic recovery in America and lifted the US dollar.
However, few market watchers expect the greenback to hold its gains for long.
In the past 12 months, the euro has charged 14 per cent higher against the $US, while its trade-weighted index, its value against a basket of currencies of the euro zone's major trading partners, has risen about 16 per cent.
Strategists haven't budged from long-standing bullish forecasts for the euro. The single currency is widely predicted to reach $US1.25 by the end of the year, $US1.30 by next year and $US1.35 by 2005, the kind of outlook that chills the region's struggling manufacturers and exporters. Last Friday, Germany reported industrial orders had sunk 2.2 per cent in May on a sharp fall in exports, for which the economic ministry blamed weak global demand and the stronger euro.
"Policymakers still look, to us, to be behind the curve," Lehman Brothers' chief economist for Europe, Michael Dicks, says.
"But at least they are starting to face up to the scale of the problem."
He cites the German government's decision to bring forward planned tax cuts worth 15 billion to early next year from 2005 as an official acknowledgement of dire growth prospects.
Dicks has just 0.7 per cent gross domestic product growth slated for the region this year, from 0.8 per cent last year, and expects a further 50 basis points to be lopped off the ECB's refinancing rate by the end of December. The central bank itself expects just 0.7 per cent growth this year.
The ECB's sins, market watchers say, range from tardiness, to poor communication, a fixation with its own credibility and chronic indecision. Its focus early in the year on the stronger euro's counter-inflationary effect, rather than the potential damage to growth, was ill-placed.
The European Commission reported euro gains had reduced export competitiveness by 4.5 per cent in the first quarter, well before the euro hit a record high of $US1.1935 in May. Cost competitiveness slid 13 per cent from a year ago, crucial to euro zone exports which make up about 15 per cent of GDP.
Even as the euro dents the international competitiveness of their goods, the euro zone's manufacturers are also being undercut by America's cheap high-tech exports and cheap low-tech exports from Asian countries, especially China, that have their currencies pegged to the US dollar.
The OECD estimates a 10 per cent rise in the euro will knock 0.8 per cent off growth in the first year of the advance, and 0.1 per cent in the following 12 months.
Germany recorded a contraction in economic growth in the first quarter of this year its second consecutive quarter of shrinkage putting it in technical recession.
It was also the second time in three years the region's largest economy sank into recession. The International Monetary Fund has warned that Germany faces the risk of deflation, something euro zone officials didn't see as a concern.
Euro zone officials surprised traders in May by peppering financial markets with statements that a strong euro was good for the region, even as the muscular currency readied for a crack at a record high. ECB president Wim Duisenberg has since changed tune, hinting a few weeks ago that Europe was bearing too much of the burden of the US dollar's decline.
That was in stark contrast to the way in which the US has backed away from its strong-dollar policy, something currency traders took as evidence of an official blessing for a weaker US dollar at a time when its economy needs help. With policymakers fuelling the mood to sell greenbacks and buy euros, currency strategists everywhere boosted their euro forecasts, giving traders higher peaks to aim for.
"Both sides of the Atlantic were paving the way for a euro at $US1.20," says Commonwealth Bank's senior currency strategist, Alex Schuman, who sees the euro reaching $US1.23 by the end of the year.
"Euro officials chose to point out euro strength at a time when it was already rallying aggressively. Such wholehearted support at that time was unusual. Usually, central bank rhetoric tends to lean gently against the direction of the move, to temper it."
So far, most market-watchers see the euro's recent levels as a fair measure of its value and a reasonable comeback after its skid in its first two years of life to a low of US82.25 cents in October 2000.
In trade-weighted terms, the euro has risen more than 21 per cent from its 2000 lows or the equivalent of more than 4 percentage points in interest rates.
But an army of economists has also noted that with some 45 per cent of the US dollar's trade-weighted index which measures the greenback's value against a basket of the currencies of its major trading partners is made up of currencies that are pegged or managed, the freely floating euro will shoulder the bulk of global investors' desire to find an alternative investment.
Bank of America's head of G10 foreign exchange research David Mozina, who believes the euro is still cheap by fundamental measures, says: "The euro is still the major currency that stands the most to gain. With fewer deep and liquid currencies about, the sad fact that China and Japan make up about 35 per cent of the US trade deficit and both have currencies which are fixed (China) or managed (Japan) makes the euro feel the bulk of the adjustment strain from global flows."
With euro-denominated fixed income assets popular among investors seeking capital appreciation and a steady decline in European investment in US equities, rate cuts won't stop buying of euros.
Boston-based investment bank State Street's research notes that, in the latest 12 months, fixed income capital flows to the region have totalled 246 billion, eclipsing equity flows of 63 billion. At the start of last year, fixed income inflows were just 90 billion on a 12-month rolling basis, compared with equity inflows of 250 billion.
HSBC's strategists point out in a research note on its customer base: "What is interesting about this is that steady euro buying has not primarily reflected speculative activity but has been concentrated mostly in longer-term flows unlikely to be reversed."
Also, the US's monstrous trade and fiscal shortfalls have driven expectations the US dollar will have to fall, making European investors, once insatiable buyers of US assets, fearful of parking capital in the US.
Their appetite for US equities peaked in October 2000 when net purchases on a 12-month rolling basis hit $US115.6 billion. By last month, net equity purchases amounted to just $US4.9 billion. In that period, the $US fell almost 37 per cent against the euro.
Europe Struggles
Another source of support for the euro emerged earlier this year when talk of Asian central banks buying euros for their foreign exchange reserves was rife. But as the $US's fall deepened, Asia's priority was to rein in its currencies, safeguarding its export competitiveness. Still, some banks see the theme continuing.
"Perhaps central banks would be tempted to change their allocation away from US dollars towards the rising euro but in a slow and methodical manner," HSBC's strategists wrote.
According to International Monetary Fund data, the world had 68 per cent of its reserves in US dollars and just 13 per cent in euros at the end of 2001. Global reserves stand at $US2.3 trillion, about two-thirds of which are held at Asian central banks.
The euro zone's embattled manufacturing and corporate sectors have been complaining bitterly in recent months. Global corporate players such as Volkswagen, technology company Software AG and consumer products manufacturers Beiersdorf AG and Henkel AG have beefed about exchange rate damage to sales and profits in the first quarter of this year.
German car makers are beginning to consider boosting their US-based production to protect their earnings, although an already high unemployment rate will make such a move deeply unpopular. Germany also has the greatest exposure to exports outside the region, with almost 20 per cent going to the US and Britain. More than 30 per cent of its stockmarket is made up of industrial and manufacturing companies who will feel the pain most from the euro's rise.
And, as if to compound the exporters' pain, they can expect little joy closer to home. Although a large portion of the euro zone's exports are traded within countries in the region, sluggish demand means such intra-region protection will be scant this year and there will be few alternative markets within the region.
In Australia, the European Union took some 16 per cent of total exports in the March quarter, up from 13.7 per cent back in the June quarter of 2001.
Here, exporters to the euro zone had little to worry about earlier in the year with the Australian dollar's value against the euro mostly steady as both currencies rallied in sync against the US dollar. But since late May, the $A has zoomed ahead of the euro, taking its gains to 12 per cent versus the single currency since the start of the year.
Aturbo-charged euro will restore balance to an investment world too-long smitten with American dollars but it also has provoked strong criticism of the European Central Bank's management of interest rates.
The euro's vigorous rise early this year warranted deeper interest rate cuts from the ECB months ago but the bank, after a minimal 25 basis point cut in March, waited until June, jeopardising the 12-nation euro zone's economic recovery.
What irks many economists is that the euro's gains to date have already wiped out the growth-friendly effects of the ECB's rate cuts and may mean future cuts may not lift the weak economy off its knees this year.
Changes to monetary policy settings usually take a minimum of six to nine months to kick in, meaning embattled borrowers will not benefit from last month's 50 basis point rate cut to 2 per cent for some time. Strategists expect the slow-moving ECB to sit pat on rates at tomorrow's meeting but consider another cut in August or September.
The euro's upswing stumbled in the last three weeks and, at $US1.1320 yesterday, it was down almost 5 per cent from a mid-June peak. Last month's rate cut from the US Federal Reserve revived hopes for economic recovery in America and lifted the US dollar.
However, few market watchers expect the greenback to hold its gains for long.
In the past 12 months, the euro has charged 14 per cent higher against the $US, while its trade-weighted index, its value against a basket of currencies of the euro zone's major trading partners, has risen about 16 per cent.
Strategists haven't budged from long-standing bullish forecasts for the euro. The single currency is widely predicted to reach $US1.25 by the end of the year, $US1.30 by next year and $US1.35 by 2005, the kind of outlook that chills the region's struggling manufacturers and exporters. Last Friday, Germany reported industrial orders had sunk 2.2 per cent in May on a sharp fall in exports, for which the economic ministry blamed weak global demand and the stronger euro.
"Policymakers still look, to us, to be behind the curve," Lehman Brothers' chief economist for Europe, Michael Dicks, says.
"But at least they are starting to face up to the scale of the problem."
He cites the German government's decision to bring forward planned tax cuts worth 15 billion to early next year from 2005 as an official acknowledgement of dire growth prospects.
Dicks has just 0.7 per cent gross domestic product growth slated for the region this year, from 0.8 per cent last year, and expects a further 50 basis points to be lopped off the ECB's refinancing rate by the end of December. The central bank itself expects just 0.7 per cent growth this year.
The ECB's sins, market watchers say, range from tardiness, to poor communication, a fixation with its own credibility and chronic indecision. Its focus early in the year on the stronger euro's counter-inflationary effect, rather than the potential damage to growth, was ill-placed.
The European Commission reported euro gains had reduced export competitiveness by 4.5 per cent in the first quarter, well before the euro hit a record high of $US1.1935 in May. Cost competitiveness slid 13 per cent from a year ago, crucial to euro zone exports which make up about 15 per cent of GDP.
Even as the euro dents the international competitiveness of their goods, the euro zone's manufacturers are also being undercut by America's cheap high-tech exports and cheap low-tech exports from Asian countries, especially China, that have their currencies pegged to the US dollar.
The OECD estimates a 10 per cent rise in the euro will knock 0.8 per cent off growth in the first year of the advance, and 0.1 per cent in the following 12 months.
Germany recorded a contraction in economic growth in the first quarter of this year its second consecutive quarter of shrinkage putting it in technical recession.
It was also the second time in three years the region's largest economy sank into recession. The International Monetary Fund has warned that Germany faces the risk of deflation, something euro zone officials didn't see as a concern.
Euro zone officials surprised traders in May by peppering financial markets with statements that a strong euro was good for the region, even as the muscular currency readied for a crack at a record high. ECB president Wim Duisenberg has since changed tune, hinting a few weeks ago that Europe was bearing too much of the burden of the US dollar's decline.
That was in stark contrast to the way in which the US has backed away from its strong-dollar policy, something currency traders took as evidence of an official blessing for a weaker US dollar at a time when its economy needs help. With policymakers fuelling the mood to sell greenbacks and buy euros, currency strategists everywhere boosted their euro forecasts, giving traders higher peaks to aim for.
"Both sides of the Atlantic were paving the way for a euro at $US1.20," says Commonwealth Bank's senior currency strategist, Alex Schuman, who sees the euro reaching $US1.23 by the end of the year.
"Euro officials chose to point out euro strength at a time when it was already rallying aggressively. Such wholehearted support at that time was unusual. Usually, central bank rhetoric tends to lean gently against the direction of the move, to temper it."
So far, most market-watchers see the euro's recent levels as a fair measure of its value and a reasonable comeback after its skid in its first two years of life to a low of US82.25 cents in October 2000.
In trade-weighted terms, the euro has risen more than 21 per cent from its 2000 lows or the equivalent of more than 4 percentage points in interest rates.
But an army of economists has also noted that with some 45 per cent of the US dollar's trade-weighted index which measures the greenback's value against a basket of the currencies of its major trading partners is made up of currencies that are pegged or managed, the freely floating euro will shoulder the bulk of global investors' desire to find an alternative investment.
Bank of America's head of G10 foreign exchange research David Mozina, who believes the euro is still cheap by fundamental measures, says: "The euro is still the major currency that stands the most to gain. With fewer deep and liquid currencies about, the sad fact that China and Japan make up about 35 per cent of the US trade deficit and both have currencies which are fixed (China) or managed (Japan) makes the euro feel the bulk of the adjustment strain from global flows."
With euro-denominated fixed income assets popular among investors seeking capital appreciation and a steady decline in European investment in US equities, rate cuts won't stop buying of euros.
Boston-based investment bank State Street's research notes that, in the latest 12 months, fixed income capital flows to the region have totalled 246 billion, eclipsing equity flows of 63 billion. At the start of last year, fixed income inflows were just 90 billion on a 12-month rolling basis, compared with equity inflows of 250 billion.
HSBC's strategists point out in a research note on its customer base: "What is interesting about this is that steady euro buying has not primarily reflected speculative activity but has been concentrated mostly in longer-term flows unlikely to be reversed."
Also, the US's monstrous trade and fiscal shortfalls have driven expectations the US dollar will have to fall, making European investors, once insatiable buyers of US assets, fearful of parking capital in the US.
Their appetite for US equities peaked in October 2000 when net purchases on a 12-month rolling basis hit $US115.6 billion. By last month, net equity purchases amounted to just $US4.9 billion. In that period, the $US fell almost 37 per cent against the euro.
Europe Struggles
Another source of support for the euro emerged earlier this year when talk of Asian central banks buying euros for their foreign exchange reserves was rife. But as the $US's fall deepened, Asia's priority was to rein in its currencies, safeguarding its export competitiveness. Still, some banks see the theme continuing.
"Perhaps central banks would be tempted to change their allocation away from US dollars towards the rising euro but in a slow and methodical manner," HSBC's strategists wrote.
According to International Monetary Fund data, the world had 68 per cent of its reserves in US dollars and just 13 per cent in euros at the end of 2001. Global reserves stand at $US2.3 trillion, about two-thirds of which are held at Asian central banks.
The euro zone's embattled manufacturing and corporate sectors have been complaining bitterly in recent months. Global corporate players such as Volkswagen, technology company Software AG and consumer products manufacturers Beiersdorf AG and Henkel AG have beefed about exchange rate damage to sales and profits in the first quarter of this year.
German car makers are beginning to consider boosting their US-based production to protect their earnings, although an already high unemployment rate will make such a move deeply unpopular. Germany also has the greatest exposure to exports outside the region, with almost 20 per cent going to the US and Britain. More than 30 per cent of its stockmarket is made up of industrial and manufacturing companies who will feel the pain most from the euro's rise.
And, as if to compound the exporters' pain, they can expect little joy closer to home. Although a large portion of the euro zone's exports are traded within countries in the region, sluggish demand means such intra-region protection will be scant this year and there will be few alternative markets within the region.
In Australia, the European Union took some 16 per cent of total exports in the March quarter, up from 13.7 per cent back in the June quarter of 2001.
Here, exporters to the euro zone had little to worry about earlier in the year with the Australian dollar's value against the euro mostly steady as both currencies rallied in sync against the US dollar. But since late May, the $A has zoomed ahead of the euro, taking its gains to 12 per cent versus the single currency since the start of the year.
Related Articles
LATEST NEWS
24/04