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Mission impossible - E (for Euro)

Ajay Jaiswal

THE danger with most sequels is that they rarely perform as spectacularly as the original. The recent price action on the Euro would have calmed few nerves as the next fall displays all the omens of outdoing the original downmove.

If the Euro's recent plunge to a historic new low is anything to go by the market should brace itself for a winter of strife for the Euro. The Euro has lost nearly 30 per cent of its value against the US dollar since it's historic debut in the market in 1999. The Euro, already under pressure from steep oil prices hikes and turmoil in the West Asia, has come under more selling as Wall Street stocks recover from recent steep declines.

Nearly a month ago, the Group of Seven major industrialized countries mounted an historic - and surprise - round of coordinated Euro-buying aimed at stabilizing the sinking currency. The threat of further action has kept Euro sellers in check, but it is unlikely monetary authorities will act at a time when West Asia tensions have sent oil prices spiraling and slowing earnings have sent stock prices reeling.

Despite the swings of the stock market, the dollar is still benefiting from investment flows. The Euro managed to claw back some gains, helped in part by comments from a Federal Reserve official who noted how the strong dollar was hurting US manufacturer s. But this sort of verbal intervention may still be too little and too late.

A lot has already been discussed as to the possible causes for the Euro's downfall. A strong US economy, weak economic figures from Euroland, chaotic decision making and comments from the ECB. But it more interesting to focus on what the ECB's future cou rse of action may be.

Given the current scenario the market may well be kept in check by the threat of another round of intervention. As of now most of the threats from the ECB; post last months intervention; have been verbal. These threats may soon be discounted and the floo r will continue to slide under the Euro.

Another worrying factor to watch out for is the apparent unwillingness shown by the US officials as well as some of the other G7 countries to participate in another round of intervention. The verbal spat between some key ECB officials and US officials un derlines this factor.

The ECB faces a great problem in trying to convince its G7 allies on the need for another round of intervention. Most allies feel the Euro still has not found a floor and that an intervention will merely provide Euro bears with another opportunity to sel l at their expense.

Alternatively the ECB can hope for a slowdown in the US economy and thereby a weaker US dollar. The sustainability of the US growth levels may come in to question in the next few months slowing capital flows out of Europe for a while. A weak Euro is hurt ing US companies and there could be pressure on the US Treasury for a vigorous response to stall Euro weakness.

Also the possibility of some large Merger and Acquisitions into Europe from the US have increased substantially as some Eurozone companies look very cheap currently. The only downside to this viewpoint is that the slowdown in the US economic performance should be gradual and soft. A hard landing will hurt the world economy as well as the Euro.

Another tool that the ECB has in it's hands is to use the interest rate mechanism to help bolster the Euro. Given the interest rate differential between Euroland and the US, there will be temptation to try and give a higher yield on Euro assets. The ECB may resort to increasing interest rates.

Given the weak data coming out it is unlikely that the ECB would raise interest rates unless a wage-price spiral threatened to take hold. Recent data released showed the Euro zone's industrial output increased by just 0.2 per cent in August for a year-on -year rise of 6.3 per cent.

A half-yearly economic report from Germany's six leading economic research institutes added to the Euro's woes, with a warning that the Euro zone was more exposed than the United States and Japan to rising oil prices. Further gloom was seen when a foreca st revealed that the German economy next year would probably grow at a slower pace of 2.8 per cent compared to 3.1 per cent this year. An interest rate hike would probably hurt the Eurozone economy as well as the Euro.

Ultimately the Euro's recovery will depend more on the resolve and determination of the member countries than on mere economic data. The fact remains that the 11 nation coalition is going to continue to speak in 11 voices and is unlikely to endear itself to the markets. Europe needs a strong head for the ECB, as a majority of the Central Bankers are not obsessed with a strong currency.

With only two weeks left to the US presidential election and Republican contender Mr George W. Bush edging ahead in the polls, it will be interesting to contemplate what his victory might mean for the dollar. His huge fiscal stimulus would stoke consumer spending and economic growth, while providing another reason for the Federal Reserve to maintain its tightening bias, all of which could be of benefit to the dollar. Mr Al Gore's plan will be ultimately less harmful for the Euro as things stand right no w.

The Euro's destiny no longer is tied in to the performance of its economy. There has to be a more decisive action from the ECB as well as a concerted action by the G7 central banks to stem the tide. If this does not happen it will take a miracle to stop the rut that has set in.

The author is Senior Manager, Corporate Treasury Sales - Southern India for HSBC. The views expressed herein are his own and not necessarily those of his employer.