Industrial, political pressure rises on ECB to weaken euro


Falling Dollar and Soaring Euro
Pose Threat of Jobs Exodus

By Ambrose Evans-Pritchard
The Telegraph, London
Thursday, February 28, 2008

The euro has surged to an all-time high of $1.51 against the dollar, prompting bitter complaints from European industry and setting of a sharp selloff in sovereign bonds from southern states deemed least able to withstand a super-strong currency.

Germany's car-maker BMW said it was slashing 5,600 jobs and warned of more drastic action if there was a "sustained rise" in the euro above $1.50.

Charles Edelstenne, head of France's Dassault Aviation, told Le Monde that the euro's rise was reaching asphyxiation level. "We can't cope with a such an exchange gap by producing and sourcing in the eurozone. The natural step is to shift to the dollar zone or low-cost areas as they have done in the car industry. This could include parts of our factory plant and some research tasks," he said.

Airbus has also drawn a line in the sand at $1.50, warning that it will have to turn its industrial structure inside out if it is to meet aircraft delivery contracts priced in dollars. The plane-maker's currency hedges will start to run out rapidly next year.

The euro's explosive move came after US Federal Reserve chief Ben Bernanke yesterday signalled further cuts in interest rates, acknowledging that tumbling house prices risked setting off a second phase of the credit crisis. "Financial markets continue to be under considerable stress," he said.

The Fed has already slashed rates from 5.25 to 3 percent since September, moving "ahead of the curve" to prevent the economic downturn spiralling out of control. The effect is to widen the yield gap with the euro-zone. This has drawn a flood of hot-money flows into Europe's money markets.

The European Central Bank has refused to budge so far, holding rates steady at 4 percent despite the credit crunch. Euro-zone inflation has reached 3.2 percent, the highest since the launch of the currency. Even so, the refusal of the ECB to start following the Federal Reserve with pre-emptive cuts as Europe's economy slows has set off a growing chorus of protest from EU politicians.

A top aide to French President Nicolas Sarkozy fired a shot across the bows of the ECB yesterday, demanding that "monetary policy must remain within reasonable bounds." The comments are a clear hint that Paris may try to force a change of tack by invoking Maastricht Article 104, which give EU politicians the power to dictate exchange policy. France has lacked allies for use of this so-called "nuclear option," but this may change now that a number of eurozone countries are now in trouble.

Spreads between 10-year German government bonds and the equivalent debt across the eurozone's Latin bloc have jumped to the highest level since the launch of EMU, reaching 45 basis points for Greece, 43 for Italy, and 36 for Greece. The spreads on Spanish bonds have ballooned to 28 from 4 last May, reflecting an abrupt change in perceptions as the property boom deflates and investors take a closer look at Spain's current account deficit, now 10 percent of GDP.

"The widening spreads are telling us that these countries are going to be hit harder than core Europe in a downturn," said Simon Derrick, head of currency research at Bank of New York Mellon.

Hans Redeker, currrency chief at BNP Paribas, said foreigner investors had largely stopped buying euro-zone bonds, suggesting that the euro rally is now on its last legs. The inflow is mostly "hot money" speculation.

Mr Redeker said there may soon come a point when the ECB's ultra-hawkish stance turns negative for the euro, causing traders to look beyond instant yield and focus on the risk that monetary overkill could tip the bloc into a deep downturn. He warned that spreads on Italian and Spanish bonds may jump to 60 basis points.

"The European economy will weaken from the periphery to the centre. Countries where there is also a lot of exposure to the housing market, such as Spain and Ireland, may find themselves in a recessionary environment," he said.

Germany is in a much better condition to weather any storm. It has gained 30 percent in unit labour cost competitiveness against Italy and Spain since 1998 by screwing down wages, and 20 percent against France.

Simon Tilford, chief economist at the Centre for European Reform, said Germany had in effect pursued a "beggar-thy-neighbour" policy, winning market share at the expense of eurozone partners. "There is potential for tensions here," he said.

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