If I had a pound, peseta, drachma or a deutsche-mark…

. . . the real effective rate would be:

Or rather, that’s the purchasing power of the euro in each of the countries featured.

As BNP Paribas notes the rates currently suggest Ireland and Spain are operating at a higher effective euro rate than Greece. More worryingly, the Greek and Spanish rates are continuing to diverge.

In which case — and in light of BBVA’s rather larger than expected loan provisions announced Wednesday– can we expect all eyes to fall upon the likes of Spain soon?

We’d be rather inclined to say yes. What’s more, we’d be inclined to make a freshly-minted euro wager that “EU competitive gap” becomes the buzz phrase of the month.

BNP Paribas’ FX team does not disagree. As they noted on Wednesday (emphasis FT Alphaville’s):

Risk takers will remain on the back foot. Fitch has expressed its disbelieve regarding Portugal’s budget proposals, while Spanish banking sector results are weaker than expected due to loan provisions.

Inner EMU spreads have continued to widen discouraging EUR investment as Europe no longer offers a homogenous bond market. The inner EMU competitive gap will remain an issue, but the surprising finding on this side is that the Spanish and Portuguese real effective exchange rate is higher than the Greek EUR, suggesting that markets might soon turn their focus to Spain and Portugal (See Chart 1).

This would put the EUR crisis into a new dimension, as Greece is only 3% of European GDP, while Iberia’s weighting is almost 20%. Europe’s periphery will have to reduce its competitive gap to keep EMU functioning. The related deflationary shock will keep the ECB on the sideline for longer than currently priced into interest rate and FX forwards. Hence, we remain outright EUR bearish across the board.

On the issue of the EU competitive gap, meanwhile, A Fistful of Euros’ Edward Hugh observed on Wednesday:

According to Strupczewski the “new European Commission report has expressed concern about gaps in competitiveness that could undermine confidence in the euro zone and point to tensions related to wage levels and capital flows in the 16-member club”. The report was prepared for the finance ministers meeting on January 16.

Of particular interest the report acknowledges that the real effective exchange rate for Greece, Spain and Portugal is overvalued by more than 10 percent – I would put the Spanish figure at nearer 20%, but still, a start is a start – and this gives us an indication of how much either wages and prices in these countries have to fall, or productivity rise, to make them competitive again, given that they are locked into the euro.

Perhaps make that a freshly-minted pound coin wager then?

Related links:
Spanish banking crises, then and now
– FT Alphaville
Moody’s still negative on Spanish banks
– FT Alphaville

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