Splitting the EURO Zone damages the EURO
By Nicholas Hastings A DOW JONES NEWSWIRES COLUMN LONDON (Dow Jones)--Good news for Germany is now bad news for the single currency as the euro zone splits even more obviously into two.
Up until this week, the strength of 'core' euro-zone economies was seen as a good thing. Larger members, such as Germany, would eventually drag smaller weaker members into growth and secure an end to the current financial crisis.
But, this has now all changed.
The failure of European leaders to provide a convincing rescue package for Ireland last weekend has only raised the risks of contagion.
The lack of political consensus in Dublin means that the risks of an Irish default, or debt restructuring, remains high.
As a result, the costs of both insuring and servicing the debt of Ireland and other peripheral euro-zone debtors, such as Spain and Portugal, will continue to rise as investors pull back even further from the region.
So, while economic improvements in Germany and other 'core' members increase pressure on the European Central Bank to exit its ultra-easy monetary policy sooner rather than later, the deteriorating conditions in peripheral countries will do just the opposite--emphasising the growing split within the euro zone.
This is not a recipe for euro recovery.
On the contrary, negative pressure has already pushed the single currency down through support at $1.3360 and it now looks set to make a run for the key 200-day moving average at $1.3136. A break of this would no doubt pave the way for a return to the sub-$1.30 levels that prevailed in late spring and early summer.
The pace of the euro's decline will of course depend on developments in the peripheral member states.
Ireland is likely to provide enough of a problem on its own. Recent opinion polls show that the opposition will more than likely topple the weak ruling coalition in a January general election.
That could end support for the country's important 2011 budget plans and make a debt restructuring much more likely. The cost of insuring the country's debt already suggests that there is a 40% chance of default in the next five years.
At the same time, rising debt costs will put Spain and Portugal under scrutiny. Although neither country has the sovereign debt problems of Greece, or even for that matter of Ireland, they will still suffer from fears of rising debt costs.
In the case of Spain, which is many times larger than Ireland, much of its government debt may be held domestically, but with its banks so heavily exposed to the plunging real-estate market, the financial sector is highly vulnerable to any hint of higher euro-zone interest rates.
Portugal's sovereign debts may not be so large but most are held by foreign investors, and with Portuguese growth in recent years proving more sluggish than most other euro-zone members, Lisbon is also ill-placed to cope with rising debt servicing costs.
In both cases, each uptick in bond yield spreads raises the cost of debt servicing and brings the possibility of debt default that much closer.
At this rate, investors will not only start pulling out of peripheral euro-zone countries, they could also start questioning support for the euro itself.
Bloomberg TNI FRX POV Reuters USD/DJ Thomson P/1066 or P/1074 (Nick Hastings has covered the foreign exchange markets and industry for more than 20 years. Apart from his written commentary and analysis, he also appears on Fox Business News and CNBC television in Europe, Asia and the U.S. He can be contacted on +44-20-7842-9493 or by email: [email protected].)
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