Thursday, May 20, 2010

Forecasts Euro to Dollar

The Euro is taking a battering. Concerns over debt default in member countries has sent the Euro falling to 1 Euro to $1.2. Some are predicting a fall towards parity with the dollar.

Why is Euro Falling?
  1. Debt in Greece looks unsustainable. Investors are nervous over the prospects of the Greek government defaulting. Since foreign investors hold a high % of Greek bonds, foreign investors have been looking to sell bonds. This puts downward pressure on the Euro.
  2. Fears over Greek debt has spread to other countries with potential debt problems such as Spain, Italy and Ireland.
  3. Poor Growth Prospects. The fiscal crisis and need for spending cuts has reduced (already weak) prospects for growth. With a very low inflation and potentially deflation rate, it becomes much more difficult to deal with debt. Debt deflation occurs when the real value of debt increases because of falling prices. It means debt to GDP ratios will continue to rise - even with spending cuts. For example, Greek debt to GDP is forecast to rise to 150% of GDP, despite austerity measures.
  4. Poor Growth Prospects reduce chance of future interest rate rises. It could even force the ECB to pursue quantitative easing which will reduce value of Euro.
  5. Concerns Over Whole Euro Project. The crisis and lack of co-ordinated response shows the weakness in a single currency area as diverse as the Eurozone. There are understandable political problems in member countries bailing out bad neighbours. For example, the French premier Sarkosy is reported to have banged his fists on the table and threatened to leave the Euro. He probably just had an 'emotional moment', but it also highlights the difficulty of using a single monetary policy to deal with the diverse problems of the Eurozone.

Forecasts for Euro in 2010 and 2011

The problem is I don't see an easy end to the Euro problems. It is one thing to implement drastic spending cuts to reduce deficit. But, this could create deflationary pressures which reduce growth further. In the absence of monetary stimulus, the scale of spending cuts could leave the Euro area struggling to recover.

The Euro is no longer seen as a good bet. You could argue, the Euros competitors are hardly any better. The US, Japan and others have serious debt problems. But, the US, at least has better prospects for growth. This gives markets more confidence that the US will be able to deal with debt.

Many markets talk about Euro Dollar Parity, and I feel that is a realistic possibility.

I hope the ECB do all that is necessary to maintain positive growth. If they allow the Euro area to sink into a recession, it would be very bad.