Euro Dollars – Europe Crisis in Rescue for Greece Bringing Euro to New Normal

Europe’s debt crisis will depress the euro still further after it declined to the lowest level since 2006, according to UBS AG and BNP Paribas SA. For years to come.

For the 16 countries using the currency, that isn’t all bad. A drop over three to four years would benefit European exporters in countries such as Germany, where foreign sales help offset reductions in government spending and restraint by consumers concerned about inflation. U.S. exports, which President Barack Obama says he wants to double within five years, may become less competitive.

“The euro depreciation is very good news for the region” because the rest of the world economy is expanding, said Charles Wyplosz, head of the International Center for Monetary and Banking Studies in Geneva. “This is going to bring a welcome boost that may save the euro zone from outright recession.”

While Wyplosz puts the euro’s long-term “fair value” at between about $1.10 and $1.20, currency movements “tend to overshoot,” he said. “My bet is that the euro still has ample room to go down before it goes up.”

Wyplosz’s view is shared by strategists at UBS, Danske Bank A/S, Royal Bank of Scotland Group Plc and Bank of America Merrill Lynch. They predict the euro will trade at between $1.15 and $1.26 by the end of the year, with BNP Paribas saying it may fall below parity with the dollar in the first quarter of 2011, according to 43 forecasts compiled by Bloomberg.

Greek Contagion

The euro fell to the lowest against the dollar in more than four years on May 17 and has lost 14 percent this year as the fiscal crisis spreading from Greece undermined confidence in the currency. Purchasing power parity, a measure of the relative cost of goods, indicates the euro remains 8.2 percent overvalued against the dollar, based on data compiled by Bloomberg.

Even if Greece is unable to meet debt obligations and is forced to reschedule interest and maturity payments, it will remain within the European Monetary Union and retain the euro, said bankers in Athens requesting anonymity because they are handling the government’s finances.

The currency’s value is still higher than the weekly average rate of $1.1833 since its introduction in 1999. The euro’s all-time low was $0.8272 in October 2000; the peak was $1.6038 on July 15, 2008.

The euro may stick at lower levels for “three, four years” as Europe grapples with its fiscal crisis, Hans-Guenter Redeker, global head of currency strategy at BNP Paribas, said in a phone interview.

ECB Strategy

The euro may fall over the next three months to $1.16 as the sovereign debt crisis forces the European Central Bank to keep borrowing costs low, Credit Suisse Group AG strategists wrote in a note to clients on May 18.

The decline in the euro may hurt demand for the region’s sovereign bonds at the time when governments are issuing a record amount of debt. Standard Life Investments said on May 18 the fund has cut its holdings of European government securities, including German bonds, citing fiscal challenges and the tumbling euro.

“Countries in the euro region are bringing forward fiscal tightening and that reduces a chance of a swift and strong economic recovery,” said Richard Batty, a global investment strategist at the Edinburgh-based fund, which has $175 billion of assets under management. “That hurts the euro. By buying euro-denominated assets, you are simply buying into the idea that the euro will remain stable.”

Three Concerns

The $1 trillion lending backstop for indebted euro nations agreed to by European leaders on May 10 also won’t halt the slide because investors remain concerned about government debt, the growth outlook for Europe’s weaker economies and trade imbalances within the euro area, said Mansoor Mohi-uddin, chief currency strategist at UBS in Singapore.

The Frankfurt-based ECB probably will refrain from raising interest rates to help offset declining government spending in the region, Mohi-uddin said. “The combination of tightened fiscal policy and looser monetary policy historically leads to a weaker currency,” he said.

Even so, pressure on the ECB to raise rates may grow as the euro’s decline feeds inflation by making imports more expensive. European inflation accelerated to a 16-month high in April, the European Union’s statistics office said May 18.

For European exporters, the euro’s biggest crisis since the monetary union’s debut is an opportunity after China overtook Germany as the biggest exporter of goods last year.

Big Headache

Bayerische Motoren Werke AG, the world’s largest maker of luxury vehicles, gets almost a quarter of its revenue in North America. Shares in Munich-based BMW have gained 23 percent this year. Paris and Munich-based European Aeronautics, Defense and Space Co., the maker of Airbus jets, has called the euro’s rate to the dollar one of the company’s “biggest headaches.”

Munich-based Siemens AG, Europe’s largest engineering company, is also looking to benefit as it competes in 190 countries, according to Chief Financial Officer Joe Kaeser. “In general, a stronger greenback is good,” he said in a May 18 conference call.

“The super-competitive export machine of Germany is going to be compensated with a very, very weak exchange rate,” said Redeker. “You have a plus-plus situation on the profitability, especially for Siemens or the car industry. They will find a very profitable situation.”

Exports account for almost half of the German economy, making up 47 percent of gross domestic product in 2008, the latest year for which full data are available.

Not Good

The biggest losers will be U.S. exporters that face a rising dollar, Barry Eichengreen, an economics professor at the University of California, Berkeley, said in a phone interview. “A weaker European economy is not good for us.”

Exports helped lead the U.S. economic recovery as the dollar declined against other major currencies last year, contributing 42 percent to the 5.6 percent growth rate in the fourth quarter of 2009, according to Commerce Department data. Since February, U.S. imports have been rising faster than exports.

While a cheaper euro may lure tourists to Europe, further boosting the continent, they may think twice about going to Greece, said Alan Ruskin, head of foreign-exchange strategy at RBS Securities in Stamford, Connecticut. He wrote in a note on May 13 that the euro could “easily head through parity” with the U.S. dollar.

Molotov Cocktails

“A weaker euro may help tourism in Greece. But on the other hand, a lot of people will be looking at the news and seeing Molotov cocktails flying through the air,” he said in a telephone interview. “That significant distraction could offset the benefit of a weaker currency.” [more]