As interest rates remain higher in Europe than in the US, the euro is becoming a popular alternativ...
As interest rates remain higher in Europe than in the US, the euro is becoming a popular alternative to the weakening US dollar as a reserve currency.
Since the end of November 2002, the euro has risen from an exchange rate of 99 US cents to around 108 US cents, according to Bloomberg.
Steven Bell, chief global economist for DWS Investments, says the exchange rate is being driven more by weakness in the US dollar than any inherent strength in the euro.
He adds people have become concerned about US structural fundamentals such as its unsustainable fiscal position, with a very large current account deficit that requires a continual influx of capital to keep the dollar afloat. Bell says: 'People are now more bearish about investing in the US. The banks of Japan, China, Korea and Taiwan are traditionally all big buyers of the dollar because their own currencies are so weak. The ECB is not buying the dollar, so the euro is rising in value.'
M&G head of global analysis John Hatherly agrees the present trend of growth in the euro is merely because it is a better alternative to the US dollar.
He says: 'A strong currency is usually symptomatic of a growing economy but this is not the case in Europe, which currently has little or no economic growth.'
Bell adds the geopolitical situation with a possible Iraqi war has had a massive influence on the euro's valuation.
He says it is making people bearish about the dollar, encouraging people to move towards the euro as an alternative currency until the war is resolved. 'I prefer to focus on fundamentals such as economic growth, which in Europe is not great.
With interest rates in the US currently at 1.25%, Europe is far more attractive for bond investors.
Over the next six months I would expect the euro to strengthen to about 1.15 against the dollar.
'If the economy in Europe surged, the euro would rapidly rise in value too, but if the US economy grows as a result of a big fiscal stimulus the dollar could bounce,' Bell says.
Hatherly believes the strength of the euro is a disadvantage for European companies that export outside the eurozone, as it decreases the value of its offshore revenues, a problem that will worsen if the currency increases further in value.
He says: 'A German car manufacturer exporting cars to the UK will have to be more competitive and lower its prices as the costs will be more attractive from the cheaper US. Multinationals with subsidiaries around the world will lose out when profits are brought back to their euro base currency.
'With poor economic growth rates in Europe and inflation slipping under 2%, we need an ECB rate cut to around 2% from its present level of 2.75% to turn things around.'
Bell says the ECB may become more aggressive in lowering interest rates, which could divert the inflow of capital to Europe and that would weaken the euro.
He adds a good global outlook is having a weak dollar against the euro but a stronger dollar against the yen.
Euro currently stronger than dollar.
Possible further growth in value of euro.
Higher interest rates in Europe.
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