Wednesday, April 7, 2010

Impact of a Weak Euro

It's been a bad week for the Eurozone. Growth in the last quarter of 2009 has been revised downwards to 0.0%. Markets show no sign of letting up on the Greek Bond Market. Continued sell offs have pushed interest rates on Greek bonds to 'unsustainable levels'

The impact of this bad news has been to weaken the value of the Euro. What will be the impact of a weaker Euro on the EU economy.

A weaker Euro would make Eurozone exports more competitive and increase the cost of importing goods into the Eurozone. It is bad news for exporters to the Eurozone (though it will not really hit UK exporters as the weakness of the Euro is being matched by weakness in Sterling)

A weaker Euro would make exports cheaper and could provide a boost to EU growth and employment. This is particularly important for Eurozone countries who rely on export led growth such as Germany.

However, the impact of a weaker Euro may be limited. Evidence suggests that demand for exports is often inelastic, a weaker currency is no guarantee of strong growth. The UK has had a weaker currency but, recovery has been weak. The impact of a weaker Euro will have a different impact within the Eurozone. I can't image a 10% devaluation in the Euro currency solving the lack of competitiveness within the Greek and Spanish economy. Much more is needed than a depreciation in the Euro. It is also important to bear in mind, the majority of trade in the Euro is within the Eurozone. For example, a depreciation in the Euro would not restore the competitiveness of Spain's exports with regard to EU partners such as France and Germany.

Inflation and A Weaker Euro

The ECB may be concerned that a weaker Euro could lead to inflation. A weak currency may cause inflation for three reason.
  • Price of imports rises (cost push inflation)
  • Demand for exports rises (demand pull inflation)
  • Less incentives for exporters to cut costs and increase efficiency.
Given the state of the EU economy, I feel inflationary pressure is very limited. But, the ECB are apt to give great importance to inflation (even when not justified). Therefore, it could raise the prospect of early interest rate rises for the Eurozone area.


Given state of Eurozone economy, a weaker Euro is no bad thing at the present moment. Overall, economic growth is sluggish, and a weaker Euro may help to boost recovery. However, a weaker Euro will do nothing to redress the imbalance within the Eurozone area. The depreciation is likely to be too little for the south (Greece, Spain e.t.c) It may prove too much for Germany. Far more is needed to solve the pressing problems in many Eurozone economies.

Forecast for Euro

It is hard to see any end in sight to the problems of sovereign debt prospects. If markets become fearful of countries like Italy and Spain the Euro could come under much greater sustained pressure.

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