WITH Greece in the ejection seat and the European Central Bank (ECB) facing a no-win decision on bond buying, the euro’s fall is far from over.
And that’s before we consider the poor economic fundamentals, not to mention the single currency’s new unpopularity with other central banks seeking a safe place to store their reserves.
The euro fell to near nine-year lows on Monday, hurt by fears that a push for vastly easier debt terms by a new Greek government, expected after Jan 25 elections, would lead not to agreement, but to Germany opening the door to a euro exit.
A report in German media that leaders in Berlin see a euro exit by Greece as “manageable” may qualify more as a negotiating tactic than an analysis, especially given that no template for such a move exits.
Either way, that we find ourselves here can be nothing other than negative for the euro, which would likely be in a cyclical decline even if its structural future were not in doubt.
The immediate consequences for the euro from a fracture in its line-up would probably be very negative, and certainly extremely volatile.
By the time we learn what kind of government Greece has elected, we will likely see important changes to monetary policy, with the ECB widely expected to make a significant announcement involving sovereign bond buying at its Jan 22 monetary policy meeting.
This may be one of those rare events in which all news is bad news for the single currency: if the ECB exceeds expectations with a large or forceful funding programme, the euro will fall almost as a matter of policy; if the ECB disappoints, the euro will fall anyway.
The idea of buying up government bonds is more popular in Germany than wholesale Greek debt forgiveness, but only just. That German Finance Minister Wolfgang Schaeuble voiced concerns about quantitative easing (QE) and lauded uber-sceptic Bundesbank president Jens Weidmann’s arguments against such moves recently implies that bond buying is far from assured.
It will be hard to deliver meaningful QE while not appearing to stray into direct financing of eurozone members, or at least the mutualisation of risk.
“Any ECB decision to go ahead with QE, without substantial modification, would now entail severe loss of face for the German government, which might be obliged to abandon the condition which has so far governed its participation in the single currency arrangements,” Stephen Lewis, economist at ADM Investor Services in London, wrote in a note to clients.
While few can agree about what the ECB should do or how Greek issues should be handled, facts, of which there are many on the ground, are not in dispute and not terribly encouraging.
Take deflation, the risk of which was illustrated by German inflation falling to just 0.1% annually in December, from 0.5% in November. Data yesterday may show the first negative such reading; that is, deflation.
Remember, the price of energy continues to decline, and its impact on inflation in the eurozone has yet to be fully felt. And while a cheaper euro is stimulative — this is partly the point of bond buying — business and consumer confidence is not helped by the way in which the riven politics show up eurozone structural inadequacy.
Then there is interesting new data showing that global central banks are no longer adding their support to the euro, something they have generally done since its inception.
While central banks will usually buy a reserve currency as it falls in order to keep their portfolios at the desired mix, that is not happening with the euro. The euro’s share of global reserves fell to 22.6% in the third quarter, according to new International Monetary Fund data, down from 24.1% in the previous quarter, a decline of €122.9 billion (RM522.6 billion).
“The euro has also become rather undesirable for central banks to hold,” Stephen Jen of hedge fund SLJ Macro Partners wrote to clients. “Nobody likes to hold a currency with a negative yield, and with the central bank managing the currency explicitly wanting the value of the currency to go down. “
Perhaps central banks are seeing the parallels between the euro and Japanese yen, which though it represents the third- largest economy in the world, accounts for only 4% of central bank reserves. Both economies face not only deflation, but seemingly intractable problems with making and implementing policy.
At some point, something will happen to arrest the fall of the euro. But not, probably, in the next month. — Reuters
James Saft is a Reuters columnist. The opinions expressed are his own.
This article first appeared in The Edge Financial Daily, on January 8, 2015.