Recession in Europe Weakens Euro

The euro weakened against the US and Japanese currencies last week following data indicating that the recession in European economies is deepening, increasing pressure on the European Central Bank to lower interest rates.

The exchange rate of the euro against the US dollar fell by 0.7 percent last week, to 1.2860 dollars. Against the Japanese currency, the euro weakened by 0.4 percent, bringing its price down to 118.50 yen. The price of the dollar, on the other hand, rose against the yen by a meager 0.1 percent, to 91.90 yen. The euro faced pressure last week due to a series of weak economic reports from the eurozone, which could prompt the European Central Bank to lower the key interest rate from the current two percent. Investors were concerned by preliminary data from Eurostat showing a record decline in economic activity in the eurozone in the fourth quarter of last year by 1.5 percent compared to the previous quarter. This marks the third consecutive quarter of GDP decline for 15 eurozone members, exceeding the 1.3 percent decline forecasted by analysts.

In the 27-member EU, GDP also fell by 1.5 percent, pushing the bloc into recession, defined as two consecutive quarters of declining economic activity, after it previously avoided a formal declaration of recession thanks to a zero growth rate in the second quarter of 2008. For comparison, in the third quarter of last year, a decline in economic activity in the eurozone and EU27 was recorded at 0.2 percent, so the latest data indicates the speed and strength of this recession. However, the dollar did not strengthen significantly against the euro as investors were not particularly impressed by the plan to rescue the US banking sector presented on Tuesday by US Treasury Secretary Timothy Geithner.

Investors are skeptical as the plan lacks clarity. The plan calls for the establishment of a public-private fund to take over bad bank assets and includes new efforts to stimulate the growth of consumer loans, reduced recourse to foreclosure measures due to inability to repay loans, and infusing fresh capital into banks. “The financial stability plan, so often touted as a sensible solution, has disappointed in several aspects. The obvious lack of concrete details regarding the removal of bad assets from bank balance sheets has further heightened uncertainties in the financial markets,” emphasizes economist Lee Hardman from The Bank of Tokyo-Mitsubishi UFJ in London.

The plan thus met with a cold response from a pessimistic Wall Street, causing leading stock indices to plunge more than four percent on Tuesday. “Risk aversion has resurfaced, following the market’s decidedly negative reaction to Geithner’s bank rescue package,” says analyst Stuart Bennett from Calyon. (Hina)