Euro Rally May Prove Short-Lived (zt)

Euro Rally May Prove Short-Lived on Rates, Asset-Purchase Bets

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By Lukanyo Mnyanda and Paul Dobson

May 10 (Bloomberg) -- Europe’s $1 trillion plan to rescuethe region’s debt-laden governments may fail to reverse theeuro’s worst start to a year since 2000 amid bets the centralbank will keep interest rates at a record low for longer.

The currency surged by as much as 2.7 percent against thedollar before paring the gain, and traded 0.4 percent higher at$1.2810 as of 1:50 p.m. in New York. It will probably declinetoward $1.20, according to UBS AG and Barclays Plc, ranked byEuromoney Institutional Investor Plc as the world’s second- andthird-largest currency traders. Schneider Foreign Exchange, thethird-most-accurate forecaster of the euro against the dollar inthe first quarter, also cut its prediction.

Traders are betting the currency will resume its decline asEurope’s economic recovery trails behind that in the U.S.,prompting the European Central Bank to keep its main refinancingrate at 1 percent this year while the Federal Reserve startsraising rates. The ECB’s decision to buy bonds may promptinvestors to question its independence and demand “a higherrisk or credibility premium,” Kenneth Broux, a senior marketeconomist at Lloyds Banking Group Plc in London, wrote in aclient note.

“The cost of securing the future of the euro is proving tobe extremely high, as can be seen by the size of the package,and there are a lot of long-term negative implicationsattached,” said Ian Stannard, a senior currency strategist atBNP Paribas in London. While the rescue package “may providesome very near-term support for the euro” it “doesn’t have animpact on the longer-term outlook,” he said.

Euro Slump

The 16-nation euro slumped 11 percent since Jan. 1, for itsworst start since the year after its introduction, on concernthe debt crisis in countries from Greece to Portugal will slowthe region’s economic recovery and prompt the ECB to buy assetswhile the Fed is exiting its own emergency measures.

The Frankfurt-based ECB said in a statement it will buygovernment and private bonds “to address severe tensions incertain market segments.” ECB President Jean-Claude Trichetsaid last week the possibility of buying assets wasn’t discussedat the bank’s last policy meeting. The decision to buy bondswasn’t supported by all 22 council members, Trichet signaled inan interview on Bloomberg Television.

The currency surged after governments pledged to make 440billion euros ($563 billion) available as part of the package,with 60 billion euros more from the European Union’s budget andas much as 250 billion euros from the International MonetaryFund. It jumped 4.4 percent versus the yen in the past two days,its biggest gain since November 2008.

‘Temporary Rally’

The gains won’t be sustained, said Mansoor Mohi-uddin,Singapore-based global head of currency strategy at UBS,forecasting a “temporary rally” toward $1.35 before a drop.

“The euro will definitely hit what we call its long-termfair value at $1.20 and it may easily overshoot that ifdifficulties in Europe persist,” he said. “The policy mix inEurope is becoming very unfavorable to the currency.”

The ECB said the moves won’t affect monetary policy and theresulting liquidity will be reabsorbed.

“We remain euro bears,” David Forrester, a currencyeconomist at Barclays Capital in Singapore, wrote in a note toclients. The agreement means “the ECB will have to play alarger role in terms of keeping monetary policy loose for longerin order to help euro area countries to grow out of their fiscalproblems.”

Analysts’ Forecasts

Economic growth in the nations that share the euro will lagbehind the U.S. by almost 1.5 percentage points next year at 1.5percent compared with 2.9 percent, Bloomberg surveys ofeconomists show. Analysts cut their euro forecasts for Juneevery month this year, predicting that it will trade at $1.33, aseparate Bloomberg poll showed. They were betting on thecurrency trading at $1.50 as recently as December.

Schneider lowered its forecast for the euro to $1.35 at theend of 2011, from $1.45, Stephen Gallo, head of market analysisin London, wrote in a research note. The euro will suffer from“ECB credibility risks, ECB balance sheet risks and EMUstructural shifts,” he wrote.

The dollar slid as much as 3.6 percent on March 18, 2009,after the Fed said it would buy as much as $300 billion inTreasuries. The Bank of England and Japan’s central bank havealso engaged in so-called quantitative easing.

“Medium-term we’d like to sell the euro against the dollarand against sterling as well, primarily because it looks likethe BOE and Fed have finished QE, while the ECB is now embarkingon a form of quantitative easing,” Mohi-uddin said.

Greek, Portuguese Bonds

Francesco Garzarelli, chief interest-rate strategist atGoldman Sachs Group Inc. in London, wrote that the effect on theeuro “of a more restrictive fiscal policy and easy monetarystance is unclear.”

“As the risk premium erodes, the currency may extend gainsagainst the dollar, returning it toward our $1.35 three- andsix-month forecasts,” he said in a research report.

Greek, Portuguese and Spanish bonds surged and German bundsslid after the package of measures to tackle the Europe’ssovereign debt crisis.

Greece’s parliament on May 6 approved austerity measuresdemanded by the European Union and International Monetary Fundas a condition to secure a 110 billion-euro bailout that maydeepen the nation’s yearlong recession.

Portugal is lowering its 2010 budget-deficit target to 7.3percent from 8.3 percent of gross domestic product, PrimeMinister Jose Socrates said May 8 in comments broadcast on RTP1television. Spain has pledged to reduce the ratio to within theEU limit of 3 percent of GDP in 2013.

At 14.3 percent of gross domestic product, Ireland had theeuro region’s largest deficit last year, followed by Greece at13.6 percent and then Spain with 11.2 percent. That compareswith an EU target of 3 percent.

To contact the reporter on this story:Lukanyo Mnyanda in London at [e-mail];Paul Dobson in London at [e-mail]