Crucial Times for the Euro

After a relatively calm summer for foreign exchange (FX) markets, volatility has returned with vengeance. The risks highlighted some months ago about holding Swiss franc finally bore fruit, as a massive intervention placed a floor under the currency. Intervention rarely succeeds but the statement of intent was sufficiently robust, that so far, it has been successful.

The euro has not fared so well. It was mentioned last week that a breakout was due and this has dully occurred, although there has been little in the way of acceleration so far. However, with Italian and Spanish yields rising – in spite of rumoured Chinese buying – and a Greek default priced in, the pressure on the single currency should continue.

Close attention should be paid to rate of deposit flight in Greece. It has reached over 21% since the crisis began, and if it continues, it will open up the spectre of a run on Greek banks. This should be the tipping point for the euro, as Germany is unwilling to provide further support. Its stance has hardened considerably since the election defeat at the beginning of September.

The open dissent that lies within the European Central Bank (ECB) with Jurgen Stark’s resignation, suggests there will be conflict and indecision at a time when it is least needed. It has little in the way of support against the Us dollar until 1.2880, providing price does not go back above 1.3990.

The most likely end game will involve the splitting of the euro into two. A ‘Dmark’ bloc of the strong economies and a peripheral countries euro. At this stage, it is not clear whether even France and Belgium will join the strong side. This may still be a considerable distance from becoming reality, but for those treasuries that have exposure to the strong countries need to be prepared, as the currency could appreciate considerably.


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Mark Carney Bank of England