Euro’s viability eroded by easing...as the US$ strengthens
Frankfurt (Apr 12) Quantitative Easing (QE) may be helping Europe achieve its economic targets, but it is also undermining the long-term viability of the euro by tarnishing its allure as a global reserve currency.
Central banks cut their euro holdings by the most on record last year in anticipation of losses tied to unprecedented stimulus.
The euro now accounts for just 22% of worldwide reserves, down from 28% before the region’s debt crisis began five years ago, while the dollar and yen’s share of holdings have both climbed, data from the International Monetary Fund (IMF) show.
“As a reserve currency, the euro is falling apart,” said Daniel Fermon, a strategist at Société Générale in Paris.
“As long as you have full quantitative easing, there’s no need to invest. The problem for the moment is we don’t see a floor for the currency. Money’s flowing out.”
European Central Bank (ECB) president Mario Draghi has in the past welcomed the drop-off in reserve managers’ holdings because a weaker exchange rate makes the eurozone’s economy more competitive.
Yet companies, including Mizuho Bank, warn that the currency’s waning popularity reflects a more lasting loss of confidence in an economy that shrank in two of the past three years.
“Global reserve managers may be thinking the euro is going to sink economically if it continues this way,” said Daisuke Karakama, the Tokyo-based chief market economist at Mizuho and a former European Commission official.
With yen allocations rising, “they may be expecting Japan’s positive economic growth to continue as a result of” that country’s record stimulus, Karakama said.
The decline in euro reserves suggests other central banks consider the ECB’s €1.1-trillion (R14-trillion) of QE bond purchases, which started a month ago, to be the biggest threat to the currency’s global status since its 1999 debut.
Greece’s debt woes are not helping either. The ECB ramped up the emergency funding available to Greek banks on Thursday to alleviate the country’s worsening liquidity issues amid drawn-out negotiations over its bailout.
All this is prompting banks from Citigroup, the biggest foreign-exchange trader, to Goldman Sachs to predict the euro will fall below parity with the dollar this year, from a 12-year low of $1.0458 last month and $1.0617 on Friday.
National Australia Bank estimates that reserve managers sold off at least $100-billion worth of euros in the fourth quarter of last year.
“Most of the fall in the euro share represented outright selling of euros” rather than simply reflecting declines in the exchange rate, said Ray Attrill, the bank’s global co-head of currency strategy.
Of the $6.1-trillion of reserves for which central banks specify a currency, the proportion of euros fell in every quarter of 2014, IMF data show. Last year was also the first time euro holdings fell in cash terms.
Yen holdings increased in three of the four quarters, and make up 4% of the total, up from as low as 2.8% in early 2009.
Dollars account for the biggest proportion at 63% after reserve managers increased their holdings in the final six months of last year. That is nevertheless down from as much as 73% in 2001.
The changes came as the yen and euro both sank 12% against the US currency last year.
The euro has tumbled by about as much since then, which should further shrink its presence in the war chests of central banks.
While Draghi has acknowledged that a weaker euro would help the region’s economy, he has repeatedly insisted his policies were not targeting the exchange rate.
His priority is to avert a deflationary spiral, after consumer prices fell in every one of the four months through March compared with a year earlier.
The euro is also falling against its broader peers, dropping more than 7% this year among a basket of the Group of 10 nations tracked by Bloomberg correlation-weighted indices, the biggest decline in the group. The dollar has climbed almost 7% on the prospect of higher US interest rates, beating a gain of about 6% in the yen.
“QE does not create the conditions for a euro recovery,” Ken Dickson, the investment director for currencies at Standard Life Investments in Edinburgh, wrote in a note on Thursday. His company oversees about $360-billion. “We retain a preference for the US dollar versus other major currencies.”