Euro update

Euro vs dollar

There is a depressingly repetitive cycle to the Euroland sovereign debt crisis. A country (or its banking sector) loses money. The government’s borrowing costs rise above 7%. The finance minster denies the need for a financial rescue. The prime minister denies it. He then concedes that his country needs a bailout. The EU/ECB/IMF troika hit-team visits to hammer out the austerity terms. The citizens set fire to banks.

From start to finish it is all about confidence. An abundance of confidence makes banks lend money to borrowers who can’t pay it back and encourages people to spend their house on fancy cars, holidays and groceries. It often results in an economic boom. A lack of confidence makes banks reluctant to lend money to anybody for anything and scares people into reducing their debts instead of buying stuff. It often results in recession.

That same lack of confidence is making investors reluctant to lend money to the Spanish and Italian governments. Yesterday (metaphorically) they were okay; today they aren’t. The challenge for EU leaders is to regenerate that confidence, especially with regard to Spain. If they cannot do it – and quickly – Spain will need a full-scale bailout. If Spain falls, Italy will be the next one in the crosshairs. It’s scary stuff.

The euro has recently touched a 2-year low against the US dollar and a 3 1/2-year low against the pound. It is not impossible to imagine Frau Merkel and her colleagues on the European Council coming up with a swift solution to the crisis of confidence that permeates Euroland. However, the experience of the last three years suggests it is not the most likely outcome, especially as they are all on holiday until September.

Sterling is close to the €1.30 barrier that held it down in autumn 2008. It will be a tough obstacle this time around too, but it would not be a huge surprise to see it move higher eventually.