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Euro Strength Damps Break-Up Talk as German Jobs Make Trichet See Recovery


Just a month ago, BNP Paribas SA, Royal Bank of Scotland Group Plc and UBS AG said the euro was heading toward parity with the dollar as Europe’s sovereign debt crisis threatened to tear the European Union apart.

Investors who bought the 16-nation currency when it reached a four-year low of $1.1877 on June 7 would have realized a return of 6.4 percent by now after the euro strengthened to $1.2641 on July 9 in New York.

“The negative sentiment was extreme,” said Mansoor Mohi- uddin, the Singapore-based head of foreign-exchange strategy at UBS, the world’s second-largest currency trader. “While we still see a lot of weakness in some euro zone bond markets, the outright pressure of the dissolution of the currency union has disappeared.”

Germany is providing the engine for changing perceptions after the euro, which depreciated 14 percent against the dollar in the first five months of the year, helped drive up exports 11.4 percent to 80.8 billion euros ($102 billion) in the same period.

Executives from Bayerische Motoren Werke AG, Volkswagen AG’s Audi unit and Siemens AG credit the currency’s decline from its 16-month high of $1.5144 in November for boosting competitiveness and making revenue earned overseas worth more when they bring it home.

Boosting Siemens

“Of course the strong dollar does help us,” Ralf Guntermann, chief financial officer of the Siemens unit that makes energy equipment from steam turbines to power plants, told analysts at the company’s capital markets day on June 29 in Nuremberg, Germany. The subsidiary is the second largest for the Munich-based company, which generated 85 percent of first quarter sales outside Germany.

BMW in Munich, Daimler AG in Stuttgart and Audi in Ingolstadt say they are adding staff and reducing summer breaks to keep up with demand that exceeded plans. Sales at BMW, world’s biggest luxury-auto maker, rose 11 percent in May, the month when the euro’s 7.4 percent decline against the dollar was the most since tumbling 8.3 percent in January 2009.

Rising sales mean unemployment in Europe’s largest economy fell for a 12th month in June, driving the jobless rate down to 7.7 percent, compared with 9.5 percent in the U.S.

Industrial Production

German industrial production increased 2.6 percent in May, more than twice the pace economists had estimated, according to figures the Economy Ministry in Berlin released on July 8. The median estimate in a Bloomberg News survey was for a 0.9 percent gain. The measure of factory output climbed 12.4 percent from a year earlier when adjusted for the number of work days.

The strengthening economy gave Chancellor Angela Merkel the flexibility to lead a four-year package of spending cuts and revenue-raising measures worth 81.6 billion euros. While Merkel is under pressure from U.S. President Barack Obama to focus on economic growth, she said the cuts, equivalent to about 2.7 percent of gross domestic product last year, aren’t enough to threaten the recovery.

The euro has lost 8.8 percent this year, the biggest loss among its developed-world counterparts, according to Bloomberg Correlation-Weighted Indexes. The dollar is up 5.1 percent, and the yen has advanced 10 percent.

The euro was at $1.2607 as of 1:17 p.m. in Tokyo today from $1.2641 in New York on July 9, when it touched $1.2722, the highest level since May 12.

Currency Hedges

The dollar’s strength also offers manufacturers the chance to lock in currency hedges that will protect export revenue for years to come, according to BWM and Audi executives.

“A euro that’s not overvalued helps our export business,” BMW Chief Financial Officer Friedrich Eichiner said in an interview last week. “We’re using the present situation to set up hedging positions for 2011 and 2012.”

Audi, a unit of Europe’s largest automaker, saw U.S. sales increase 14 percent last month, led by its compact A3 model and A5 two-door coupe.

“We’re benefitting from the strengthening dollar and are taking advantage of the favorable situation to expand our currency hedging in the U.S.,” Axel Strotbek, chief financial officer, said in an interview last week.

Euro Forecasts

Strategists continue to forecast a weaker euro on concern that Europe’s fiscal crisis may expand beyond debt-laden Greece and Spain to Germany and France. Forecasts for the euro were slashed 18 percent this year against the dollar, the most of any major currency, based on the median of as many as 43 estimates. They expect the euro will trade at $1.19 by year-end.

Hans-Guenter Redeker, head of global currency strategy in London at BNP Paribas, was one of the first to predict euro parity with the dollar as Greece’s debt woes pushed up bond yields. France’s largest bank said May 6 the European Central Bank would loosen monetary policy to avoid deflation, driving the euro down to $1 by March of 2011. Three days later, the ECB said it would buy government debt to arrest the crisis.

“We are firmly committed to our view,” Redeker said in a phone interview July 8. “Inflation is going to stay low for a long period of time, so is the interest rate,” damping demand for the euro, he said. A fair value for the euro is $1.14 and the EU would have “much more” trouble retaining membership if it stays stronger than that, Redeker said.

‘Darker Scenarios’

The euro would drop to $1.10 by year-end under a best-case scenario as the EU’s efforts, including the 750-billion-euro bailout package designed to keep borrowing costs from rising and contain the region’s budget deficits, only postpone the crisis, Alan Ruskin, then head of foreign-exchange strategy at RBS Securities, wrote in a June 10 note to clients.

“Other darker scenarios, like contagion stemming from a de facto Greek default, will make sub-parity levels inevitable,” Ruskin said. He will join Deutsche Bank AG in August as global head of Group-of-10 foreign-exchange strategy in New York.

“The underlying fundamentals for the euro remain, unfortunately, negative for the euro,” said Mohi-uddin of UBS. “Those fundamental issues remain the sustainability of debt in countries like Greece. The imbalance in the region persists. The tighter fiscal policy will lead to weaker growth which means the ECB will have to keep its policy looser for longer. This will push the euro lower against the dollar in the second half of this year.”

Greek Deficit

Greek Finance Minister George Papaconstantinou said last week that the country may beat a target to reduce the budget gap to 8.1 percent of gross domestic product from 13.6 percent as tax increases and spending cuts kick in and the economy contracts less than forecast.

Meeting those targets is key to Greece receiving 110 billion euros of emergency loans from euro-area leaders and the International Monetary Fund to stave off default.

Besides Germany, the euro’s depreciation has helped the rest of the euro countries, too.

Italian industrial output rose 1 percent in May from the previous month, the statistics office Istat said last week. Spain’s National Statistics Institute said July 2 that industrial production rose for a third month in May, while jobless claims declined. Ireland’s Central Statistics Office said June 30 that the economy expanded for the first time in more than two years in the first quarter.

Excessively Pessimistic

“There is a tendency from the outside to be excessively pessimistic” about Europe, European Central Bank President Jean-Claude Trichet said at a June 8 press conference in Frankfurt after the ECB left its benchmark interest rate at a record low of 1 percent. “The figures don’t confirm this pessimism.”

Futures traders decreased bets that the euro will decline against the dollar to the least since Jan. 12, figures from the Commodity Futures Trading Commission in Washington show.

The difference in the number of wagers by hedge funds and large speculators on a decline compared with those on a gain, so-called net short amount, was 38,909 on July 6, compared with 73,670 a week earlier and a record 113,890 on May 14.

“The market has been too pessimistic on the sovereign risk issue in the euro area,” said Bilal Hafeez, head of currency strategy in London at Deutsche Bank, the world’s biggest foreign-exchange trader.

“One thing you have to bear in mind is that despite the debt problem in Greece and other peripheral countries, the overall fiscal deficit in the euro region is relatively small,” said Hafeez, who predicts the euro will appreciate to as high as $1.35 in six months. “Europe is going to be benefitting from a weak euro.”