The euro has risen to an eight-month high against the dollar (chart via Reuters):
And the unease over what it means for Europe’s weak sovereigns and economies is rising too.
Exhibit A on Wednesday — this Credit Suisse chart:
And to think it’s all because of the quantitative easing beauty contest, thanks to M. Trichet’s determination to normalise money markets.
The strong euro looms large in the bank’s decision to downgrade continental Europe to benchmark, from the it-can’t-get-much-worse overweight position assigned to it in May. As Credit Suisse observe:
1) With exports outside the Euro area accounting for 16% of GDP, each 10% on the euro trade-weighted takes nearly 0.8% off European GDP growth and 0.7% off inflation—Europe’s exports account for 40% of GDP and 40% of these exports going to countries outside the monetary union… Thus each 10% on euro trade-weighted takes 1.5% off nominal GDP growth.
2) 36% of European corporate earnings come from outside of Europe. We estimate that each 10% appreciation of the euro would reduce earnings by about 11% – directly and indirectly (since the end of June the euro is up 7% trade-weighted and thus should have reduced EPS estimates by 8%). This could be even higher when we consider the lags involved (increased competition from third markets).
3) Finally, the more the euro strengthens, the more deflationary pressures are likely to be exerted on peripheral Europe which in turns threatens to raise the risk premium for Europe as a whole.
On that last point — we’ve noted before that Europe’s peripheral sovereigns just can’t win when it comes to the euro’s value, since competitiveness problems keep their real effective exchange rates elevated even as the euro weakens.
Credit Suisse has a chart on this aspect of the problem too:
And they link it to Europe’s sovereign crisis thus:
While we continue to believe that markets have exaggerated the risk of a break up of the Euro area, we are still very worried about the risk of sovereign restructuring in peripheral Europe. The biggest problem is that any country that has experienced a banking crisis typically had to generate excess savings or else have a very undervalued currency in order to generate high capital inflows. Typically, over a banking crisis, the current account moves from a big deficit to a large surplus (as in the case of Non-Japan Asia or Mexico)…
However, although there has been some big shifts in the current accounts, we still find that that Ireland, Greece and Portugal have current account deficits of 1.9%, 6.2% and 8.2% respectively for this year on EIU numbers (our economists estimate the current account deficits in 2011 to be 0.6%, 8.6% and 10% respectively). This suggests to us that in Portugal’s case, it still has to attract foreign capital flows (in this case the ECB) of around 8% of GDP.
So, while the peripheral sovereigns have plenty of other problems on their plate — it rather looks like they don’t need a strong euro on top of them.
Although if you’re going to talk up a currency war, you should expect unwarranted collateral damage at some point.
Full note in the usual place.
Related links:
Drowning in euros – FT Alphaville
Prepare for 10 years of FX ‘super-volatility’ - FT Alphaville
Currency wars - FT / In depth