Currency weakness appropriate for Euro area according to Bank of Ireland
The euro has fallen steadily on the foreign exchange markets in the year to date, declining by 8% on average against the other major currencies with half the depreciation recorded in the month of May.
- Euro falls to 4-year low against Dollar
- Currency realignment will support euro growth
- Euro is now nearer fair value
The euro has fallen steadily on the foreign exchange markets in the year to date, declining by 8% on average against the other major currencies with half the depreciation recorded in the month of May. The single currency’s fall against the US dollar has been more pronounced, at 15%, taking the euro to below $1.22 on occasion and as such back to levels last seen in 2006 and a far cry from the high of $1.60 recorded two years ago, according to Bank of Ireland’s latest Bulletin which was published today, 3 June 2010.
According to Dr. Dan McLaughlin, Group Chief Economist, Bank of Ireland: “The speed of the recent fall appears to have unnerved some European policy-makers but the decline in the euro is appropriate given recent economic developments. The eurozone economy grew by just 0.2% in the six months to end-March, against 0.7% in the UK and 2.2% in the US. This wide divergence in relative economic performance has resulted in a substantial shift in interest rate expectations in favour of the dollar. Two-year interest rates in euro, for example, are trading at 1.35% and as such very close to US rates (1.25%) whereas the differential in favour of the euro was 0.75% six months ago. In other words investors are no longer receiving a significant interest rate premium to hold euros over dollars and that has hit the single currency.
“The risk of a Greek debt default and the political confusion surrounding the subsequent bail-out has also hit confidence in the euro, of course, but in the absence of that development the single currency would probably have fallen anyway given its mediocre growth performance. Any change in the euro’s external value is neither good nor bad as it represents a transfer between consumers and producers – a fall in the euro reduces the spending power of consumers, including those in Ireland, but represents a potential benefit for producers selling into dollar markets. Euro growth should therefore now benefit from the currency’s fall as it may boost exports and it should also be noted that the euro is still far from being cheap – most studies put the ‘fair value’ for the euro/dollar rate at around $1.20 at most, (coincidentally its average value over the past decade) implying that it has been significantly overvalued for the last few years.
“We had anticipated a euro/dollar fall to around $1.30 and we now expect the currency to trade in a $1.20 to $1.25 range with the risks to the downside, although speculative traders have sold the euro to an unusually large degree, which means that they have to buy the currency at some stage, which offers the best short term support”, concluded Dr. Dan McLaughlin.
3 June 2010
Dr. Dan McLaughlin
Group Chief Economist
Bank of Ireland Global Markets
Tel: 01 609 3221
Bank of Ireland
Tel: 076 623 4772