The real test for the euro is yet to come
WITH the European Central Bank’s (ECB) stress tests now out, euro optimists are coming out of the woodwork. Goldman Sachs upgraded its forecast to predict the euro will hit $1.35 against the dollar in early 2011, while ETX Capital similarly forecasts that its current rally could last to the $1.35-36 level. Evolution Securities is likewise bullish about the Eurozone, declaring the consensus to be “far too downbeat about the outlook for Eurozone growth.”
Optimists point to better-than-expected Eurozone data, such as industrial production figures, as indicative of underlying strength. In its monthly FX update, Goldman suggests “the risks are more manageable” than they were, citing Europe’s balance of payments surplus and the transparency of the stress tests as evidence. As a result, Goldman’s 2010 GDP growth forecast for the Eurozone is above consensus at 1.4 per cent.
This shows that many analysts now believe that euro strength will come not just in relation to the dollar on the back of weak American data, but because the euro has been oversold. ETX Capital’s David Hutchings agrees with Goldman that the stress tests have buoyed market confidence: “It’s given some reassurance to the market. There was some fear that more banks would fail but seven out of 91 was not too bad and we’re now resuming the upward trend of the last month and a half.” Figures in the last week seem to bear him out, with the euro rising from its Friday low of $1.28 to over $1.30 yesterday.
But while many think that the euro could be past the worst of its troubles, others maintain that little has changed. Last month, Lombard Street Research’s Gabriel Stein forecast that the euro would fracture over the next five years due to a likely Greek default. He says: “To keep the euro, they have to fuse fiscally; otherwise they will split.” As for the stress tests, he is scathing: “It’s like a saying from the days of the Soviet bloc: ‘we pretend to work and they pretend to pay us’. The tests were done to pretend we can all relax now but there are still so many question marks.” He highlights the failure to test banks’ strength in the event of a sovereign default as a major point of uncertainty.
And despite the euro’s rally against the greenback, it has so far failed to regain the ground lost to sterling after the release of last week’s strong UK GDP figures. Forex brokers suggest that medium-term pound-euro strength is here to stay: Currencies.co.uk’s Stephen Hughes says the number of limit orders to buy euros if sterling hits €1.25 has increased 35 per cent since last week, whereas before traders were settling for a more pessimistic €1.20.
Meanwhile, despite the positive figures, most fiscal squeezes have yet to come into effect. The real test of the Eurozone’s stability will not be issued by the ECB, but by the forex markets and their response to the financial and political upheaval to come.