EUR Under Sever Pressure

By: eToro
The Euro fell under major support levels amid failure of EU members to conclude a rescue plan for Greece. Germany the largest economy in the EU is strongly opposing any sort of a Greek bailout. Latest polls show a large portion of Germans not only opposes any sort of a Greek bailout but actually think Germany is better off without Greece in the Euro zone.

With the EU strongly divided ahead of the EU summit on Thursday and Portugal’s credit downgraded by Fitch to AA- , investors crowded heavy bids on the Euro pushing it below the 1.34 support against the Dollar and to a historic low of 1.423 against the Swiss Franc.

Many other members of the EU are under debt watch such as Spain, Portugal, and even Italy, and investors’ willingness to pay a premium for the Euro against the Dollar is starting to fade.

Lack of a safety net, a long term risk for Euro zone growth -The failure of EU members to create a funding safety net not only poses a risk for the Euro exchange rate but for Euro zone economic growth.

Since investors have a lack of clarity and feel the Euro zone is unable to be flexible enough to address its debt problem in an orderly manner, spreads on various bonds of EU members are widening. This brings borrowing costs for governments in the Euro zone to surge. For example the spread between Greece’s 10y borrowing costs and Germany’s 10y borrowing costs is 3%, meaning Greece’s borrowing costs are close to two times that of Germany, as German 10y bunds are yielding 3.25%.

Now with Portugal credit downgraded and Greece possibly forced to get an IMF loan, many EU members that need to rollover vast amounts of debt could suffer the same surging borrowing costs.

What is the effect of such a process? Inflation could spike in the Euro zone which could cause the ECB to prematurely raise rates and bring EU growth practically to a standstill. Moreover since investors in the future will not be confident on EU stability, EU members will have to earn investors’ trust by curbing deficits too rapidly and this is of course also negative for growth and risk a double dip recession in the Euro zone.

Unless EU members will be able to create a long term solution and a safety net for the EU high debt nations, investors’ belief in the Euro Zone will fade and with it any chance for the EU to gain a stable economy and exchange rate.