Renewed strength of euro threatens economy

Renewed strength of euro threatens economy
By Matthew Saltmarsh
Copyright by The International Herald Tribune
Published: March 20, 2009
http://www.iht.com/articles/2009/03/20/business/euro.php


PARIS: After a brief respite, the euro is gaining strongly against the currencies of its main trading partners, further threatening the Continent's wilting economy. That is adding to pressure on the European Central Bank to enact radical steps similar to those that are weakening the dollar, the pound and the Swiss franc.

A rising currency typically dampens demand for exports, an important component of growth. That in turn slows production in factories, with ripple effects on related industries and on jobs.

Since the start of the month, the euro has gained about 7.8 percent against the dollar, 4.7 percent against the pound and 3.1 percent against the franc.

Despite falling on Friday, the euro still posted its biggest weekly gain of the year against the dollar. In late trading in New York, it was at about $1.36.

Jean-Michel Six, chief European economist at Standard & Poor's, forecast that the euro would push through $1.60 by the end of September, and also pass the parity level against the pound by then.

"If the euro keeps rising, it will be really grim news for the euro economy, which is already in very bad shape," said Paul de Grauwe, a professor at the Catholic University of Leuven in Belgium.

Even before the recent rally, exports from the 16-country euro area had been decimated. During 2008, the region recorded a trade deficit of €32.1 billion, compared with a surplus of €15.8 billion in 2007.

The value of exports from Germany, the world leader in manufactured goods, fell more than 20 percent in January, the sharpest drop in 16 years. Industrial production in the euro zone has fallen for five straight months.

The main reason for the currency's rise, analysts said, is because central banks in the United States, Britain and Switzerland are taking radical steps to increase the amount of dollars, francs and pounds in circulation to try to revive lending. But their actions, known as "quantitative easing," also carry inflationary risks.

The E.C.B., based in Frankfurt, has chosen not to follow this path, for now.

"All eyes are on Frankfurt," said Jim O'Neill, chief economist in London at Goldman Sachs. "Foreign-exchange markets are sensing that there's a new game unless they do something more to facilitate a weaker euro."

There are now some signs of discontent from policy makers, who fear that the European economy is bearing a disproportionate burden in the global adjustment that is under way.

One euro-zone finance ministry official, who asked not to be identified because he was not authorized to speak publicly, said that the falling pound could soon start to cause distortions in the European internal market, if inexpensive British goods started winning market share in the euro zone and in outside markets.

"It could become a substantial problem," he said.

After coming to power, President Nicolas Sarkozy of France berated the E.C.B. on a number of occasions for not doing enough to revive the economy.

But for now, French officials are wary of putting more political pressure on the E.C.B. even if exporters based in France, like EADS, the parent of Airbus, suffer as the euro rises.

Berlin has always been loathe to back steps that might compromise the independence of the E.C.B., and French officials are aware that they need German cooperation on a host of other economic issues, from market regulation to bank bailouts.

Relations between France and Germany are only just starting to improve after recent tensions.

Still, the finance ministers of France and Ireland, as well as the governor of the Bank of Italy, have in recent weeks grumbled about the low level of the British currency, comments that have raised eyebrows in the market.

The level of the pound is important for the euro zone. It accounts for 21 percent of the E.C.B.'s nominal effective exchange rate, a weighted average of euro currency rates against its major trading partners. The dollar accounts for 24 percent.

There appears to be less concern about the weak dollar, something that many European officials feel is needed to bring down the U.S. current-account deficit and help rebalance the world economy.

Switzerland also been taking steps to weaken its currency, the franc. The Swiss National Bank intervened last week in foreign-exchange markets. The bank also said it would buy corporate bonds as it cut its benchmark interest rate to 0.25 percent from 0.5 percent. But Switzerland is a less important trading partner.

The E.C.B. has room still to lower its benchmark interest rate, which at 1.5 percent is the highest in the Group of 7. The Federal Reserve and the Bank of Japan have lowered their key rates to close to zero and the Bank of England's is at 0.5 percent.