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Euro drops because closed US markets dont crash { December 2008 } Original Source Link: (May no longer be active)
http://www.bloomberg.com/apps/news?pid=20601087&sid=ahIPTuco2xC0&refer=homehttp://www.bloomberg.com/apps/news?pid=20601087&sid=ahIPTuco2xC0&refer=home
Euro Set for Dollar-Like Swoon as Wages Brake Growth (Update5)
By Bo Nielsen and Lukanyo Mnyanda
Jan. 21 (Bloomberg) -- It's only a matter of time before the euro starts to imitate the dollar, thanks to train engineers and ticket-takers.
Germany's GDL union, representing 30,000 rail workers, won a pay raise of 11 percent last week, ignoring pleas by the European Central Bank to keep increases to a minimum. As many as half of the 150 million employees in the euro-zone may use the contracts as a benchmark in wage talks this year, said Holger Schmieding, the London-based chief European economist at Bank of America Corp., the second-largest U.S. bank.
The newfound spending power may force ECB President Jean- Claude Trichet to keep interest rates at a six-year high longer than he would like in order to contain inflation, according to Geoffrey Yu, a currency strategist at UBS AG. The longer they're on hold, the bigger the risk to economic growth and the euro's 20 percent rally over the past two years. The premium that traders are paying for euro put options, which rise in value when the currency falls, is the highest in almost three years.
``Investors who are looking for growth are allocating out of the euro,'' Yu said. UBS is the world's largest currency trader after Deutsche Bank AG. ``We really don't see value in the euro-zone economy,'' the Zurich-based strategist said.
The euro has fallen 2.3 percent since the start of last week to a three-week low of $1.4444 as of 1:10 p.m. New York time today. The currency will decline 3.2 percent to $1.40 per dollar this year and another 7 percent to $1.30 in 2009, according to the median of 43 forecasts compiled by Bloomberg. Against the yen, the euro may slide 1.5 percent to 151 in 2008 and another 5.3 percent to 143 in 2009.
Holding Rates
ECB policy makers refused to follow the Federal Reserve, the Bank of England and the Bank of Canada in cutting rates, saying inflation is still too strong to warrant a reduction. The Fed's target rate for overnight loans between banks is 4.25 percent, down from 5.25 percent in September. The ECB has kept its main refinancing rate at 4 percent since June.
The ECB will ``not tolerate'' an inflation spiral of rising prices and wages and will ``act preemptively'' to maintain stability, Trichet said in Frankfurt on Jan. 10, three days before the GDL union obtained its raise. ECB Executive Board member Juergen Stark said today the bank still expects the economy to expand about 2 percent this year and remains ready to raise interest rates. Inflation will average 2.5 percent in 2008, exceeding the ECB's aim of just below 2 percent, the bank said last month.
Slower Growth
``The longer the ECB waits, the more risk they'll be taking with growth, and you could see the euro come under pressure,'' said Divyang Shah, chief strategist in London at CBA Europe Ltd., a unit of Commonwealth Bank of Australia.
CBA expects the euro to fall about 9 percent by year-end, the most of any of the 43 estimates compiled by Bloomberg.
Growth in Europe's $10.2 trillion economy will likely decelerate to 1.8 percent this year, from 2.6 percent in 2007, according to a Dec. 19 Bloomberg survey of 18 economists. A separate poll shows that the U.S. may expand 2.1 percent, compared with 2.2 percent in 2007.
The GDL union's deal was almost four times the euro- region's 3.1 percent inflation rate in December. Germany's Ver.di labor union, the country's second-largest with about 2.3 million members, is asking for an 8 percent increase.
``The ECB should focus on concrete measures rather than speculate about price developments that workers aren't responsible for,'' said Frank Bsirske, the Berlin-based head of Ver.di. ``For several years, workers in the public sector and elsewhere have been forced to endure real cuts in pay.''
Euro Reserves
A slowdown in Europe's economy may not be severe enough to slow the trend among investors to increase their euro- denominated holdings at the expense of the dollar, said Sylvain Broyer, a Frankfurt-based economist at Natixis, France's fourth- largest bank by market value.
The euro's share of global foreign reserves rose to 26.4 percent at the end of September, from 18.1 percent in 1999, according to the International Monetary Fund. The dollar accounted for 63.8 percent, down from 71.1 percent.
Higher bond yields in Europe may also give investors an incentive to buy the euro. German notes due in two years yield about 1.13 percentage points more than U.S. Treasuries of similar maturity, the most since 2003.
Futures Show Cut
The ECB has been known to cut rates even as consumer prices rose. The central bank lowered borrowing costs in 2001 with inflation at a seven-year high of 3.1 percent to contain the fallout from a decline in global stock markets. The euro fell 5.6 percent that year before rising 18 percent in 2002.
Interest-rate futures show traders are betting the ECB will cut borrowing costs as a slowdown takes hold. The yield on the December Euribor contract, a proxy for where investors are betting the rate may be in the future, fell to 3.7 percent from 4.4 percent in the past month.
Euro bears may have to wait until after June to see a payoff, according to Frankfurt-based Deutsche Bank. The currency may appreciate to $1.55 against the dollar in the first half of the year as the U.S. economy cools, the firm predicts. It will weaken to $1.37 by January and then $1.30 in 2009 as the slowdown moves to Europe.
``There's still much talk in Europe about workers getting a bigger share of the economic recovery when in fact we have already begun the slowdown,'' said Thomas Mayer, chief European economist at Deutsche in London. ``Europe will be in a growth recession later this year while the U.S. is rebounding, and that will obviously take its toll on the euro.''
`More Difficult'
The difference between two-year euro put options, which provide the right to sell the currency, and calls, which allow for purchases, reached negative 0.57 percentage point this month. The so-called risk-reversal rate, used as an indicator of sentiment in the foreign-exchange market, shows traders were more bearish on the euro than at any time since March 11, 2005.
Resolution Investment Management Ltd. will start to be ``underweight'' the euro in July, said Stuart Thomson, a money manager who helps oversee $46 billion in bonds at the Glasgow, Scotland-based firm.
``It's becoming more difficult for the euro,'' Thomson said.
Last Updated: January 21, 2008 13:22 EST
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