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EU: Euro Falls As Investors Look To U.S. To Lead Economic Recovery

  • Mark Baker

The introduction of euro notes and coins at the start of the year was expected to boost the euro's value on international currency markets. But since 1 January, the euro has fallen with respect to its main rival: the U.S. dollar. RFE/RL correspondent Mark Baker spoke this week with currency traders about the reasons behind the weakness of Europe's common currency and the flip side of the coin -- the surprising strength of the dollar.

Prague, 30 January 2002 (RFE/RL) -- The launch of the euro at the start of the year was expected to boost the value of Europe's common currency with respect to its main rival, the U.S. dollar.

But instead of rising, the euro has fallen, touching a six-month low of around 85 U.S. cents earlier this week (28 January).

The euro has now lost about 3 percent of its value with respect to the dollar since euro notes and coins began circulating in the 12-nation eurozone on 1 January. The currency has fallen more than 25 percent since its inception three years ago.

The drop this week came in spite of good news from Germany showing that the economic slowdown there may be over. A widely respected index of business confidence among German companies, the Ifo index, rose in January for a third month in a row.

The German economy is the euro-zone's largest national economy and positive news from Germany should help the euro.

But John Kyriakopoulos, a currency strategist at J.P. Morgan in London, says economic data coming out of the euro-zone economies -- like the Ifo index -- are not that important because currency traders remain fixated on the U.S.

"Despite the rise in the [German] Ifo [index] that we saw earlier in the week, it didn't really change investor perceptions that the economy leading the recovery was going to be the U.S., and hence sentiment remains fairly negative regarding the euro."

Kyriakopoulos tells RFE/RL investors continue to see dollar-denominated financial assets -- primarily U.S. stocks and bonds -- as offering the best prospective returns on investment, and therefore money is still flowing into the United States.

"I think the dollar is being supported by expectations for a stronger and earlier recovery in U.S. growth. That is [why we are] seeing continuing capital inflows into the U.S., which is why the dollar is performing so strongly at the moment."

The relative strength of the dollar is surprising since it comes at a time when the U.S. economy remains mired in recession and the prices of U.S. financial assets, such as stocks, have fallen.

Moreover, the U.S. central bank has lowered its benchmark interest rate several times in the past year to levels not seen since the 1960s. Lower interest rates tend to reduce demand for a currency by reducing returns on interest-sensitive assets like bonds.

But currency analyst Kamal Sharma at Commerzbank in London says traders now see signs -- such as falling inventories at factories -- that the U.S. economy is recovering.

"[The rising dollar is based] purely on the hopes of an upswing in the U.S. economy in the months ahead. We're looking at the inventory numbers that are showing that the inventories are continuing to be drawn down, implying an imminent rebound in production."

Besides, Sharma tells RFE/RL, currency traders have little to choose from since growth prospects for all three main currencies -- the dollar, euro, and Japanese yen -- remain relatively poor. He says the dollar is seen as the best among a weak choice of options.

"Effectively, we're in a tripartite currency regime -- the euro, the yen, and the dollar being the most actively traded currencies at the moment. [The U.S.] is really the best of a 'worst set' of economies to invest in."

The European Commission and some currency traders earlier this year predicted that the introduction of euro notes and coins would lead to a recovery in the value of the euro by making the currency more visible and thus more credible. Some said the euro could soon reach parity with the dollar or even approach its 1999 inception value of $1.17.

But the euro has declined steadily since its inception as Europeans, in greater and greater numbers, purchased U.S. stocks and bonds, and currency traders questioned the viability of a common currency shared among 12 independent nations.

Sharma says traders were impressed by the relatively smooth launch of euro notes and coins this year and the currency did get a small boost. But he says attention quickly focused again on economic fundamentals, and the euro began to fall.

"The focus shifted straightaway back onto economic fundamentals: the prospects and potential for growth in 'Euroland' versus the growth in the U.S. this year."

Economists say, on a positive note, that the weaker euro has helped the euro-zone economies blunt the effects of recession by making their exports relatively cheaper and therefore more competitive. By the same token, the stronger dollar has probably hurt the U.S. economy by making its exports relatively more expensive.

But Kyriakopoulos says the European Central Bank will have to monitor the euro closely to make sure it doesn't fall too far and therefore possibly spark inflation.

"The risks of an excessively weak euro relate to inflation picking up in the region. To the extent that occurs, then it probably means that policymakers would err on the side of too-tight monetary policy, which would severely constrain economic recovery for the euro region."

The weakness of the euro has led to a fall in the value of many currencies in Central and Eastern Europe, where economies are tied closely to the European Union.

One exception, however, has been the Czech Republic. The Czech crown has not only trumped the euro this year, it's kept pace with and even appreciated against the U.S. dollar.

Traders say the strength of the Czech crown is temporary and tied to the government's ambitious program to sell off state-owned assets denominated in crowns.

"I think the Czech [crown's] development has really been driven by privatization flows. There's been a very aggressive privatization campaign, program, by the Czech government. And that's led to huge amount of inflow of receipts into the Czech economy."

Traders say they expect the crown to move back into line with the euro once the sell-off is complete.

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