Bloomberg News

Lira Beats Mark as Europe Suffers From Stronger Euro

November 21, 2012

Lira Beats Mark as Europe Suffers From Stronger Euro

Mixed denominations of Lire notes, Italy's former currency, are seen in this arranged photograph in Rome. Photographer: Alessia Pierdomenico/Bloomberg

Europe’s economy, shrinking under the weight of a three-year debt crisis and rising unemployment, would be better off if its currency behaved more like the Italian lira than the deutsche mark.

At least that’s the view of a growing number of investors and analysts, who say the euro is too strong for Europe’s good. The shared currency trades 5.5 percent above its lifetime average of $1.2102, and is 2.6 percent higher than it should be against the dollar, data on purchasing power compiled by the Organization for Economic Cooperation and Development show.

The euro has gained more in the past three months than any of its nine developed-market peers in Bloomberg Correlation- Weighted Indexes, even with the region’s unemployment rate at a record 11.6 percent. Instead of acting like the mark, the bulwark of Europe’s foreign-exchange markets before 1999, economies and companies would become more competitive if the euro echoed Italy’s lira, which weakened about 30 percent in the decade before countries did away with individual currencies.

“The euro is not sustainable at these levels in the medium-to-long run,” Ulrich Leuchtmann, the Frankfurt-based head of currency strategy at Commerzbank AG, Germany’s second- biggest bank, said in a phone interview on Nov. 19. “This has to be an economic area with a soft currency, more like the lira before 1999 than the deutsche mark. A weaker currency will help to contain some of the problems.”

Purchasing Power

The 17-nation common currency declined 0.1 percent to $1.2801 as of 11:09 a.m. London time today. It gained 0.7 percent to 105.41 yen. After closing at $1.18 on Jan. 1, 1999, it has traded as high as $1.6038 in July 2008, and as low as 82.30 U.S. cents in October 2000.

The euro has strengthened 4.2 percent since a pledge by European Central Bank President Mario Draghi on July 26 to do whatever it takes to safeguard the monetary union. It was 2.7 percent undervalued against the dollar the day before he made that vow, having weakened to a 2012 low of $1.2043 on July 24, according to data from the Paris-based OECD, which uses relative costs of goods and services.

The shared currency may fall back to $1.23 by the end of 2013, Leuchtmann said. The median of at least 46 strategists’ predictions compiled by Bloomberg is for the euro to end this year at $1.28, before slipping to $1.25 by December next year.

“The euro is still a strong currency, relative to where it came in,” Richard Clarida, a global strategic adviser at Pacific Investment Management Co., said in a panel discussion at the Bloomberg FX12 Summit in New York on Nov. 14. “Given the macro fundamentals in Europe, a euro at $1.20 would not be the end of anyone’s world, or even a euro at $1.15. It’s not clear what’s supporting it now.”

Depreciating Lira

Italy’s currency weakened to 1,659.90 against the dollar on the last trading day of 1998, from 1,169.25 on Dec. 31, 1987, according to data compiled by Bloomberg. Germany’s mark was at 1.6767 per dollar on its last day before the euro’s debut, from 1.5708.

Over that period, Italy’s economy expanded at an average 1.64 percent per year. Growth in Germany, which was reunited in 1990, averaged 1.36 percent between 1992 and 1998, data compiled by Bloomberg show.

The lira was devalued by 7 percent against the mark in September 1992 and Italy left the European Exchange-Rate Mechanism, which had been intended to reduce currency-market volatility. When it rejoined the ERM in November 1996, the lira had lost more than 20 percent against the German currency.

Corruption Investigations

The financial market turmoil provided a backdrop for corruption investigations beginning in 1992, which led to the collapse of Italy’s dominant political parties. That opened the door for Silvio Berlusconi to enter politics. He was elected as prime minister in 1994, and his first government lasted less than a year. Italy elected another four prime ministers by April 2000.

Germany has had three leaders since reunification in 1990, with Angela Merkel as Chancellor since 2005.

Currency debasement to boost exports is no longer an option to offset spending cuts needed to bring deficits of countries including Italy, Spain, Portugal and Greece to within European Union limits. That’s creating a dilemma for Draghi, who needs to balance inflation across all euro-area nations even as he takes steps to tackle the sovereign debt crisis.

For Marcus Hettinger, a foreign-exchange strategist at Credit Suisse Group AG in Zurich, policy makers’ efforts to reorganize the currency bloc’s economy are already showing success and the euro will probably climb to $1.35 in the next year, as investors remove bets on the monetary union collapsing.

Budget Deficits

“If you look at the whole of the euro zone, then the debt is lower than the U.S. and the government deficit is lower,” Hettinger said in a Nov. 14 telephone interview. “It’s just that in the past year or two, some investors have had the impression that it’s not a single entity anymore.”

The nations that share the euro will probably reduce the region’s budget deficit in 2013 and 2014, according to Bloomberg surveys of economists. They will also record current-account surpluses, the broadest measure of trade in goods and services, of 0.9 percent and 1.3 percent of gross domestic product, compared with shortfalls of 3 percent of GDP in both years for the U.S. The surplus means that Europe isn’t reliant on foreign capital to fund its investment and spending.

While the euro has weakened about 0.7 percent in the past month, according to Bloomberg Correlation Weighted Indexes, it has strengthened 2.4 percent in the past three months. Since its creation in 1999, the euro has depreciated about 15 percent.

Net Shorts

Hedge funds and other large speculators are increasing bets the European currency will weaken. The difference in the number of wagers on a decline in the euro compared with those on a gain was 83,646 on Nov. 13, compared with 67,141 a week earlier. That’s the most since the period through Sept. 14.

Euro-area GDP contracted 0.1 percent in the third quarter after a 0.2 percent decline in the previous three months, data showed on Nov. 15. The economy will probably shrink 0.5 percent this year and grow 0.1 percent next year, according to economists’ predictions compiled by Bloomberg, while the U.S. is forecast to expand 2.2 percent this year and 2 percent in 2013.

Italy’s unemployment rate rose to a seasonally-adjusted 10.8 percent in September, the highest since the third quarter of 1999, the Rome-based national statistics office Istat said on Oct. 31. Spain’s joblessness is a record 26 percent.

Asset Purchases

That contrasts with recovering growth and hiring in the U.S., where the Federal Reserve completed two rounds of stimulus and said in minutes of last month’s meeting published on Nov. 14 it may increase efforts to sustain an expansion. American employers added more workers than economists predicted in October even as the unemployment rate rose to 7.9 percent, Labor Department figures showed on Nov. 2.

The Fed bought $2.3 trillion of mortgage and Treasury debt from 2008 to 2011. The ECB purchased the equivalent of about $280 billion of European debt through the Securities Markets Program it announced in May 2010. It sterilized those purchases by taking the cash back as deposits to avoid stoking inflation and hasn’t used the program since March.

“It would be very helpful if the ECB could be as loose as possible and push down the euro,” Michael Siviter, a money manager at Invesco Ltd. in London, which oversees $683 billion, said in an interview on Nov. 16. “A weaker currency would help the growth profile.”

Siviter said he forecasts the euro will depreciate against the dollar, declining to give a forecast.

Export Demand

European Aeronautic, Defence & Space Co. (EADS), which hedges to manage currency risk on future Airbus aircraft deliveries, loses 1 billion euros of earnings for every 10-cent increase in the euro against the dollar. Sanofi, maker of the world’s best- selling insulin Lantus, said on Oct. 25 that exchange-rate movements had a positive effect of 6.4 percentage points on third-quarter sales growth after currencies including the dollar strengthened against the euro.

Weaker export demand is set to spread to the euro region’s larger nations, the European Commission said this month. Shipments from Germany, Europe’s biggest economy, shrank 1.5 percent in September. Italy and Spain reported export declines of 0.8 percent and 1.2 percent, respectively.

The ECB needs to ease monetary policy, which will cause the euro to depreciate to $1.15 within a year, John Hardy, the head of foreign-exchange strategy at Saxo Capital Markets in London, said in a Nov. 16 phone interview.

“The peripheral economies absolutely must be able to devalue and at the moment they are not able to do that,” Hardy said. “They are just in a horrible situation and they need a weaker currency.”

To contact the reporters on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net; Emma Charlton in London at echarlton1@bloomberg.net

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net


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