Bloomberg News

Euro Sustained in Widest Rate Gap Since ‘09 as Greeks Vote

June 27, 2011

(Updates euro’s price in second and 11th paragraphs.)

June 27 (Bloomberg) -- Euro bears driving the region’s shared currency to its first two-month loss in a year are facing rising interest rates, bullish bets in futures markets and Angela Merkel’s determination to keep the 17-nation bloc intact.

The euro slid 4.2 percent since April as mounting concern that Greece would default drove Prime Minister George Papandreou to change finance ministers amid a push for 78 billion euros ($110 billion) in austerity measures to tap more financial aid. The yield on 10-year Italian bonds rose to a record relative to German bunds last week and Spanish yields approached an all-time high on speculation the crisis will spread.

The bears are confronting the resolve of German Chancellor Merkel and French President Nicolas Sarkozy to defend the currency and the widest gap between euro and dollar money-market rates in about 2 1/2 years as German economic growth outpaces the U.S. BNP Paribas SA sees the euro at $1.55 by year-end, with Commerzbank AG saying it may advance to $1.50 before weakening.

“The political desire to keep monetary union alive continues to be overwhelming,” said Audrey Childe-Freeman, the head of European currency strategy in London at the private-bank unit of JPMorgan Chase & Co., the second-biggest U.S. lender by assets. “If we get the debt crisis more under control and we see more momentum in the global economy, the environment will become more supportive for the euro.”

Rate Signal

The difference between the three-month euro interbank offered rate, that European banks say they see each other charging over the period, and the corresponding London rate for dollar loans, has increased to 128 basis points, the most since January 2009. The gap widened this year as the European Central Bank began raising interest rates, while the Federal Reserve kept borrowing costs at a record low.

Hedge funds and other large speculators are betting on a gain in the euro versus the dollar, figures from the Commodity Futures Trading Commission in Washington show. So-called net longs, or bets on a rise, were 29,771 on June 21, compared with a net-short bet as recently as January, according to the data. Net longs reached 99,516 in May.

European Union leaders vowed last week to prevent a Greek default as long as Papandreou wins the backing of parliament this week for the proposed budget cuts. Merkel said in Brussels on June 24 that there was agreement within Europe for a new aid program for the nation.

‘Important Decision’

“This is an important decision that says once again we will do everything to stabilize the euro overall,” she said, after backtracking a week earlier on German demands that bondholders be forced to shoulder a “substantial” share of a new Greek bailout.

China will keep investing in Europe’s sovereign bond market, Premier Wen Jiabao told the British Broadcasting Corp. in an interview yesterday, saying the purchases “show our confidence in the economies of Europe and the euro zone.”

The euro strengthened 5.7 percent against the dollar this year, behind only the 12 percent gain by the Swiss franc. Most of the common currency’s gain occurred in the first quarter as ECB President Jean-Claude Trichet indicated in March that higher interest rates were on the way and EU leaders established a permanent rescue mechanism for the region. The euro is little changed versus the greenback since March 31.

Trichet Concern

The shared European currency fell 0.8 percent last week to $1.4188, and weakened 0.3 percent versus the yen to 114.13. The euro has advanced 2.2 percent this year against a basket of nine other developed-nation currencies as measured by Bloomberg Correlation-Weighted Indexes. The euro was little changed at $1.4199 at 8:54 a.m. in New York.

European leaders are struggling to contain the debt crisis that began in Greece when Papandreou’s Pasok party, elected in October 2009, discovered the budget deficit was more than twice as big as the previous government had disclosed. A 750 billion- euro backstop crafted by the EU and International Monetary Fund more than a year ago failed to stem concern that more euro-area governments would struggle to finance record budget deficits.

Trichet said on June 22 in Frankfurt that risk signals for financial stability in the euro area were flashing “red” as the crisis threatens to infect banks, posing “the most serious threat to financial stability in the European Union.”

Italian, Spanish Bonds

Investors are demanding higher yields to hold the bonds of Italy and Spain, while the Greek 10-year yield gap over bunds, Europe’s benchmark sovereign securities, climbed to a record 15.43 percentage points on June 17.

The Italian-German spread climbed to 2.16 percentage points on June 24, the most since the euro’s introduction in 1999, and the Spanish 10-year yield difference widened to within 13 basis points of a record. Bond yields of Portugal and Ireland, which also sought bailouts, rose to all-time highs versus German debt last week.

Standard & Poor’s cut Greece’s credit ranking on June 13 by three levels to CCC, the lowest debt grade for any government. The ratings company said the nation is “increasingly likely” to face a debt restructuring.

“The worst for Greece is definitely not behind us,” said Stephen Jen, a managing partner at SLJ Macro Partners LLP in London. “The Europeans and International Monetary Fund have done things to buy time, but they’ve bought time without a plan. I see a new low in the euro later this year.”

Fed Forecast

The median of 50 analyst estimates compiled by Bloomberg shows the euro will end the year at $1.41, little changed from last week’s close. Deutsche Bank AG, the world’s biggest currency trader, says the euro has set its 2011 high and low and will trade between $1.30 and $1.50 through Dec 31.

“There have been distinct forces capping the euro on the upside this year, and distinct ones capping it on the downside,” Caio Natividade, the London-based head of foreign- exchange derivative strategy for Deutsche Bank, said in a telephone interview.

The slowing U.S. recovery has also provided support for the euro. The Fed lowered its full-year growth forecast last week, saying the economy will expand 2.7 percent to 2.9 percent versus a range of 3.1 percent to 3.3 percent estimated in April. The Bundesbank said on June 10 that German gross domestic product will rise 3.1 percent in 2011, up from a 2.5 percent increase predicted in February.

‘Euro Resilient’

Trichet said on June 9 that the ECB may boost rates next month even as he damped investor expectations for the pace of future increases amid slowing forecasts for inflation. European policy makers raised the main refinancing rate a quarter percentage point to 1.25 percent in April, the first increase in almost three years.

The ECB’s benchmark will be 2 percent by the first quarter of next year, according to the median of 27 economist forecasts compiled by Bloomberg. The Fed, whose target for overnight loans between banks has been a range of zero to 0.25 percent since December 2008, won’t raise the rate to 0.5 percent until the first quarter, a separate median survey showed.

“The reason the euro is resilient is that the ECB doesn’t seem to be affected by all the events in Greece,” said Ulrich Leuchtmann, head of currency strategy in Frankfurt at Commerzbank, Germany’s second-largest lender. “This is a strong signal as it shows ECB policy is independent of what’s happening in the crisis-hit countries.”

Leuchtmann said the euro will probably climb to $1.50, before weakening to $1.45 by year-end.

Greece Vote

The first session of a three-day debate in Greece on new budget cuts is scheduled to begin today. A vote is expected on June 29. An implementation law, which provides the technical details of how the five-year plan will be applied, is also due to be discussed and approved by the deadline of June 30.

Merkel said at the June 17 press conference in Berlin that she “would like to have a participation of private creditors on a voluntary basis” for more Greek aid, what Sarkozy said was a “breakthrough.” The two signaled a reconciliation between German calls for investors to help rescue Greece with warnings from the ECB and France that compulsory participation risked triggering the euro area’s first sovereign default.

“This whole Greek fiscal drama is going to be resolved in a manner that is going to be positive for the euro,” said Mary Nicola, a foreign-exchange strategist at BNP Paribas in New York. “The fact that Germany has made a concession, and a debt swap deal has been ruled out, is a huge positive.”

--With assistance from Andrea Rothman and Benedikt Kammel in Paris and Jennifer Ryan in London. Editors: Mark McCord, Daniel Tilles

To contact the reporters on this story: Liz McCormick in New York at; Lukanyo Mnyanda in Edinburgh News at

To contact the editors responsible for this story: Daniel Tilles at; Dave Liedtka at

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