The Euro has weakened significantly against the dollar

16th January 2012

Its decline has been widely anticipated, with hedge funds holding record high bets against the currency, but the long-term implication of a weaker Euro is now exercising strategists.

Gavyn Davies in the FT believes that a weaker Euro should prove part of the solution for the Eurozone, going some way to mitigate the effects of the bailout:"Many economists have seen the decline in the euro as a symptom of the wider sovereign debt crisis, but actually it could prove to be part of the solution, not part of the problem. The euro is still not "weak" on the foreign exchange markets in any long term sense, and a further significant decline in its real value is not something to be feared." 

He admits that while a weaker Euro will not solve the competitive discrepancies within the Eurozone – the heart of the problem – it will reduce the overvaluation of the peripheral countries against the world as a whole.

Davies' views were generally well-received. Only community member Doubting Thomas questioned the premise that the Euro had weakened, suggesting the real issue was a strengthening in the US$: "There is a vital difference between these two positions. The $ strengthened not only against Euro but almost all the currencies like A$, C$, Sing $, NOK, etc., etc., and even against gold. US $ could have been said to have strengthened against the Euro, had it done so only against it while remaining constant against all the rest or that Euro would have fallen against all the major currencies too along with the US$." However, this appears to ignore the weakness of the Euro against sterling. The UK remains one of the Eurozone's key trading partners.

Certainly, there appears to be good grounds for believing Davies' premise that the declining Euro will act to boost Eurozone economies: "If it lasts for six months, a euro "devaluation" of this sort could add a point economic growth in some eurozone countries (and also make existing loans a little cheaper to pay off), analysts say. That, in turn, could spare the EU as a whole from sinking back into recession and facilitate the reform process in troubled eurozone economies such as convalescent Italy."

"If we get one side benefit from sovereign-debt issues, a weakened euro…would be an extremely welcome outcome," said John Whelan, chief executive of the Irish Exporters Association, whose member firms account for 80% of Ireland's exports. Effects of a lower euro should feed through quickly, particularly with the euro weakening against the U.K. sterling. The U.K. accounts for roughly 50% of the exports of Irish-owned businesses, mostly small and medium size, Mr. Whelan said."

It is already being seen in company results. For example, Philippe Pichetto, who runs the Americas export division for French cognac maker Louis Royer SAS, says the weaker euro has already been positive for sales. Paulo Vaz, who heads Portugal's textile association, is quoted as saying the weaker euro "will help Portuguese textiles exports, especially for countries outside the European Union." Portugal is home to roughly 7,000 textile-related companies, which account for 10% of its exports.

Of course, what is good for the Eurozone may not be as helpful elsewhere. The weaker Euro is already having an impact in the US with a number of companies reporting a dent in profits: "Safra Catz, Oracle co-president, said when the Redwood Shores, Calif.-based company reported second-quarter results on Dec. 20 that the appreciation of the dollar created "a percent negative swing" on results. Still, European sales rose 2 percent in the quarter.

"IBM's CFO, Mark Loughridge, said the demand for new computers and services outweighed any increase in the dollar. IBM's third-quarter European revenue rose 9 percent to $8 billion but were flat when adjusted for currency."

The same article said that American manufacturers generally believe that the euro will have to fall further to hurt U.S. competitiveness significantly. U.S. exports fell slightly in October from September, the Commerce Department said last week. But capital goods-the area where the U.S. competes most directly with Europe-rose. The impact of a weakening Euro has not yet been seen in weaker export figures from the UK, but this may be a longer-term consequence.

What does this mean for investors? Buying Eurozone assets is cheaper, but here Moneyweek editor John Stepek argues that they are not yet cheap enough: "European stocks – while getting cheap – could get cheaper still as the crunch point approaches. So while I'd be starting to look at stocks to buy in the region, I would also hang on to a large chunk of cash, to be ready to buy in at the most promising time." However, it also means that those investors currently holding Eurozone assets will face the drag of a depreciating currency.

The weaker currency may play its part in resolving the Eurozone crisis, in which case it is good news for everyone. However, the price may be some weakening of exports in the region's trading partners such as the UK and US. 

 

More from Mindful Money:

UK investors pull out of equities – but should they be fearful?

Ireland: The surprise winner of the 2011 stockmarket

Euro breakup – Have you planned ahead?

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