Euro falls on bad debt fears

2 June 2010

Sterling hit a one-and-a-half-year high against the struggling euro as fears over bad debts held in eurozone banks dealt the single currency a further blow. The pound climbed to €1.19 - its highest point since December 2008.

Meanwhile, the beleaguered single currency was slinking back to a four-year low against the dollar as investors continued to look for a safe haven, since the eurozone's woes show no sign of abating.

This led to fears that economic growth will slow dramatically - and could result in further write downs for the banks.

The European Central Bank warned in its financial stability report that European banks face another €195 billion in potential write downs over the next 18 months.

Joshua Raymond, market strategist at City Index, says: "The key here is that the report admitted that should sovereign risks and budget cuts slow economic growth, there is a risk that write downs could be more than predicted."

Demand for exports is also likely to drop as countries look to rein in their debt levels. The latest Chinese factory data highlighted a slowdown in new orders in May.

Analysts at Commerzbank said: "The situation remains difficult for the euro. Concerns about the consequences of the savings measures that have been initiated in many countries demonstrate how bad sentiment for the joint currency currently is."

This negative outlook piles the pressure on the euro further. It was dealt yet another blow last week after credit rating agency Fitch downgraded Spain's sovereign rating.

This was reduced from AAA to AA to reflect the agency's expectations that the country will see a more muted economic recovery following its austerity measures.

Meanwhile, the unexpected resignation of German President Horst Köhler did little to improve sentiment. Barclays Capital said the resignation "amounts to a blow to Chancellor Angela Merkel, and it may also send a signal of political instability - in times of a heightened level of domestic economic and political challenges".

With the eurozone in a prime mess, commentators are not expecting a turnaround in the euro's fortunes anytime soon.

Rupert Watson, head of asset allocation at Skandia Investment Group, says: "For the last few years, the euro has appeared overvalued against most currencies, including the US dollar and the UK pound.

"Given the fiscal tightening in some eurozone countries, the likelihood of very low interest rates for a long time to come and the lack of confidence in the region further falls in the euro are possible."

Phil McHugh, senior dealer at Currencies Direct, adds: "If the euro falls under the psychological level of 1.20 against the dollar, a fresh barrage of euro selling will occur and the risk of debt crisis contagion spreading to Portugal, Italy and Ireland will become a reality."


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