In a recent e-mail to a friend, I brought up the Euro as an example of central bank involvement in our economy. The following article is my interpretation of the discussion that took place and how it may impact on the ECB. There are many considerations for the Euro, both good and bad.
The euro is an “A” rated currency and the risk of a possible default will be on the minds of its investors. If the Greeks fail to pay their debts then there could be a total collapse of the economy. This can also have ripple effects throughout the European Union and beyond.
The Bank of England (BOE) has a role in the creation of the currency and the relationship between the two is often referred to as the “B” rating of the euro. The B rating is the highest rating the central bank has. So if there is a downgrade in the rating of the currency to BBB or lower this would have major implications for the economic outlook for the world.
The euro’s weakness is also noted by the BoE. So will the BoE affect the economic outlook for the euro? The current situation is more than likely to impact negatively on the markets. But we don’t know what the BOE will do.
Now then, if we look at the actual Euro in comparison to other major currencies, the comparison is quite simple. The current value of the euro is lower than the British pound. The yen is lower than the Canadian dollar. The US dollar is significantly higher than the Swiss franc.
The current weakness of the EUR is seen by traders and investors as a positive sign of strong growth in the EU. So the outlook is positive for the Euro. The UK was losing ground on the value of the Euro prior to the current crisis.
Now if we look at the recent history of the Euro, we see a widening of the gap in the European Monetary Union. So this would suggest that the people that expect weak growth and weaker investment in the European Union are right. But it also points to the potential strength of the economy.
The actual stock market performance for the Euro is quite weak. This could be due to the debt problems in the countries where the Euro is issued. People feel the debt will force the Euro into a stronger economy and they may want to hold onto the Euro. If we examine the history of the European Economic Community we see a significant dip in the Euro.
The current weakness of the Euro will encourage investment from foreign investors and this could strengthen the recovery in the economy. What will this mean for the BOE? This could have a number of impacts on the economic outlook of the Euro including allowing the BoE to cut rates.
The rate decision will be more expensive if the Euro is stronger. So if the economic indicators change, so will the interest rates. We are at the point now where the media is talking about the near end of the “Golden Age”. The central banks are all trying to figure out how to deal with the current situation.
The ECB has warned that there could be a situation where deflation could occur. The central bank may be taking a risk to cut rates by a large amount. If we look at the history of the value of the Euro, we see a wide range of moves before and after the last break down of the Golden Age.
So in conclusion the weakness of the Euro may mean the Fed will lower their rates and the BoE may decide to raise theirs. But the economy could still be weak.