Can The Euro Stand The Heat?

The ECB interest rate rise two weeks ago has left investors like the cat that got the cream and the euro fighting fit. But how long can the party last?

 

The EU seems sat on the financial equivalent of a pressure cooker right now. Each morning brings reports that turn the heat higher on the indebted PIG nations – plummeting credit ratings and rocketing bond yields and more. The question is: Can the euro stand the heat? Can the euro face these nerve-knocking reports head on and stand firm against currencies including sterling and the US dollar?

Let’s take a closer look.

Headaches for the PIGs

In the last 24 hours alone the PIG nations have suffered a trio of blows to the head. IFO boss Hans-Werner Sinn has told the Wall Street Journal that Portugal might become a bottomless pit – a hole into which cash disappears without ever getting full. Ireland has had its credit rating slashed to Baa3 with negative outlook through Moody’s. Greece meanwhile stands on the brink of default according to financial information service Markit.

In short it’s all but over for these countries. In spite of IMF bailouts and ECB handouts the fat lady has sung and the bird has flown the coup.

However the euro could not be more chipper – trading at near-recent peaks against sterling. So what gives?

Heavyweight euro

Two factors in particular have kept the euro fighting fit. Two weeks back the European Central Bank upped interest rates for the first time since the global financial markets exploded in 2009. For investors this was the equivalent of hearing a cash register ring – it meant returns on EU bonds received a sudden testosterone boost. In addition the pace of German economic expansion resembles a rocket car. Each new release indicates that the German machine is unstoppable.

But focusing on German economic growth as the PIG nations falter is like ignoring the tornado that’s wrecking your house because the bedroom hasn’t been hit. It isn’t a bright idea in the first place and must at some point stop. So what happens when the markets can no longer ignore the elephant in the room and one or more of the PIG nations defaults?

Expect the euro to fall through the floor.

End to the party?

Next to nations such as Britain that have taken bold strides to rebuild their economies the EMU is a house founded on sand. For the euro to survive either PIG nations must be shown the business end of a steel-toed boot and kicked out – or the Germans themselves must abscond. Either means months of hand-wringing from EU politicians before a decision is announced – leaving the euro teetering on the brink of oblivion

The best bet then? Keep a close watch on the situation in Greece and other nations – and take advantage of euro strength before the milk curdles.

 

By Peter Lavelle with specialist foreign exchange broker Pure FX.