The eurozone fears another 'brutal' shift - Could the dollar's fall - and the euro's rise - pose a danger to the eurozone's economic recovery?

The eurozone fears another 'brutal' shift - Could the dollar's fall - and the euro's rise - pose a danger to the eurozone's economic recovery?
By Ralph Atkins in Frankfurt
Copyright The Financial Times Limited 2006
Published: November 28 2006 02:00 | Last updated: November 28 2006 02:00


The events of the past few days bear an eerie resemblance to late 2004, when the euro also rose significantly against the dollar, peaking on December 31 at above $1.36 and raising fears about growth prospects in the 12-country region.

Against the dollar, the euro is already higher than the point at which Jean-Claude Trichet, European Central Bank president, attempted verbal intervention on the foreign exchange market. On November 8 2004, he described "brutal" currency movements as unwelcome. For the following year, the eurozone economy remained in the doldrums.

A rule of thumb used by economists is that a 10 per cent appreciation of the euro, on a trade-weighted basis, knocks roughly a percentage point off growth in the following year.

But even if the euro's appreciation is sustained, the eurozone economy is significantly stronger, and thus better equipped to withstand a gain in its currency, than in 2004. Growth in gross domestic product this year is on course to be the best since the start of the decade: indeed, the euro appears to be rising largely because of the region's bright growth prospects, which have encouraged speculation that eurozone interest rates will also rise.

True, eurozone growth slowed in the third quarter, in which GDP rose by 0.5 per cent, but that was still ahead of the US and may have represented a correction after an exceptionally strong 0.9 per cent spurt in the previous three months. Business confidence indicators suggest that there has been little let-up in the final months of the year. Germany's Ifo index was last week back at a 15-year high.

"It is hard to believe that you have a serious problem on your hands when German business tells you it has never been better," says Robert Barrie, economist at Credit Suisse. German industry has made large strides in competitiveness, with labour costs firmly under control, and may even gain ground on US rivals despite the currency's strength.

Michael Hüther, director of IdW, the German economic institute in Cologne, argues that the euro at $1.30 will create few difficulties, especially given currency hedging by companies. "German companies can swallow that. There are enough ways to insure against a falling dollar." Problems would be created, however, if the dollar's decline accelerated.

"With fast, jerky fluctuations companies don't have enough time to protect themselves," he says.

Other countries may be more severely affected than Germany. Jacques Cailloux, economist at Royal Bank of Scotland, sees countries such as Italy, Portugal and Spain, which manufacture lower value-added products than Germany, faring worse. France - where politicians' anxiety about the euro's strength and the European Central Bank's apparent indifference was yesterday strongest - "sits somewhere in the middle", Mr Cailloux adds.

But so far the eurozone is still expected to notch up another respectable growth performance in 2007 and the euro's appreciation is still some way from causing a downgrading of forecasts.

Ralph Atkins