WORLD / Wall Street Journal Exclusive
Euro's surge poses risks
By MARCUS WALKER (WSJ)
Updated: 2006-11-27 15:19
http://online.wsj.com/public/article/SB116459211707233191-1rHAX5GJ05NkyXZCU
rvopZoyjgE_20061204.html?mod=regionallinks
BERLIN -- The euro's sudden sprint to near its all-time high against the
dollar could herald more gains against the US currency, harming European
growth and exports, especially if signs of a US economic slowdown gather.
But how -- and if -- the European Central Bank responds to the currency's
rise could greatly influence how deeply the pain is felt.
The euro's surge to $1.3097 Friday happened amid low trading volumes
following the US Thanksgiving holiday. Even if the euro tide recedes in
coming days, the diverging paths of the US and European economies could
drive the euro to record levels in the months ahead, according to many
forecasters.
"It could be the start of something big," says Ken Wattret, chief
euro-zone economist at BNP Paribas in London. The euro's all-time high is
$1.36, touched in December 2004.
Exchange rates are shaped by the currency market's view of whether
central banks will raise interest rates, reflecting strong growth and
inflation, or cut them to cushion an economic slowdown. Rising interest
rates attract more investors to that currency.
Recent data on the US economy have shown weakness in manufacturing and
retail sales, as well as a bigger-than-expected fall in housing starts
last month. That is fuelling concerns that the housing slowdown will hold
back consumption and overall growth. Many financial-market participants
expect the US Federal Reserve to cut interest rates early next year.
In contrast, economic data in Europe have been robust. "It looks
increasingly like Europe hasn't caught cold from the US sneezing," says
Neville Hill, an economist at Credit Suisse in London.
Against that background, the ECB is widely expected to raise its key
interest rate another quarter point, to 3.5%, at its Dec. 7 meeting. But
markets are waiting to see whether ECB President Jean-Claude Trichet
drops a hint about another rate increase in early 2007 and what comments
he makes about the euro.
"If the ECB says 'the exchange rate is no problem, we're still very
confident about the growth outlook and worried about inflation,' the euro
could go higher," says Mr. Wattret of BNP Paribas. But if the ECB
expresses concern about a fast-rising euro, he says, that would limit the
euro's rise. Markets would take that as a signal the ECB could pause from
boosting rates in early 2007 as it monitors how the currency and the
economy are faring.
Amid fears that a stronger euro could hurt European exports, which are
vital to the region's growth prospects, European stocks fell Friday. The
pan-European Dow Jones Stoxx 600 fell 0.76% to finish at 355.98.
A strong and lasting rise in the euro has undercut an economic upturn in
Europe before: In 2003 and 2004, signs of life in Europe's
long-struggling economy were snuffed out as the euro soared to its high
mark from 87 US cents. Since then, many European businesses have grown
used to a stronger euro, and the region's economy has launched a recovery
during the past year underpinned by rising exports.
Some caution against reading too much into the euro's latest gains. Light
volumes helped make the currency market volatile on Thursday and Friday,
compared with recent years, which have seen currencies move in narrow
ranges.
"There doesn't appear to have been any clear driver behind the moves,
which makes these moves questionable as a guide going forward," said Ken
Dickson, who heads the currency team at fund managers Standard Life
Investments of Edinburgh.
On its own, the euro's rise to just over $1.30 -- after hovering between
$1.25 and $1.28 for the past six months -- won't greatly affect growth or
inflation in Europe. But many economists are worried that trends during
the year ahead could drive the euro up to around $1.40.
In addition to signs of economic slowdown in the US, which are weighing
on the dollar, various central banks in East Asia and the Middle East are
thought to be undertaking, or considering, a shift in their currency
reserves, buying more euros to diversify away from dollars.
A sustained rise in the euro to around $1.40 from around $1.28 would
knock roughly half a percentage point off economic growth in the euro
zone next year, according to BNP Paribas. Many economists predict a
cocktail of German tax increases, slower global growth and a stronger
euro would cut euro-zone growth to below 2% next year, from more than
2.5% this year.
A persistently stronger euro would hurt exporters across the euro zone,
but some countries would suffer more than others. German exporters,
having made big efforts to boost efficiency in recent years, are
considered the best equipped to cope with a high exchange rate. Also,
Germany specializes in high-end products such as specialized machine
tools and luxury cars. Those are less price sensitive than mass-market
consumer products that compete directly with Chinese goods.
But even German exporters would widely feel an impact on sales from a
euro valued at $1.35, according to a survey last month by the
Munich-based Ifo economics institute.
In Italy, currently the weakest of Europe's major economies, the pain
would be greatest. Many exporters in Italy's large shoe, clothing and
furniture sectors compete with low-cost Asian rivals, and the country has
struggled to cope with the euro even at lower levels.
Spanish and French exporters have also lost global market share in recent
years and suffer when the euro rises. But unlike the Italian economy,
Spain and France are growing anyway, thanks to strong consumer spending
and continuing housing booms.
A saving grace for many European exporters is that their increasingly
global investments reduce their costs in euro terms. At Italian eyewear
maker Luxottica Group SpA, for example, a large US store network means
that about 65% of its costs are in dollars, giving it a natural hedge
against a rising euro.
"The most important thing for us is that the economy in the US stays
healthy," says Luxottica spokesman Luca Biondolillo.
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