Europe’s next casualty: Maley

Foreign exchange markets were in turmoil overnight, with the euro plunging to a 10-month low against the US dollar as a rescue package for Greece remained elusive, and investors fretted that sovereign debt fears were about to infect Portugal.

German Chancellor Angela Merkel is insisting that the financial assistance to Greece will only be a ‘last resort’ in the event that Greece is unable to raise funding in international capital markets. Greece has to refinance $US28 billion of debt by the end of May.

In exchange, Germany wants to introduce tough new laws that would impose stricter budgeter discipline on the 16 countries in the eurozone. Germany is also calling for the International Monetary Fund to make a ‘substantial contribution’ towards any Greek rescue.

As European Union leaders gather in Brussels for a two-day summit, Merkel has scored something of political victory with her tough stance on Greece, with French President Nicolas Sarkozy softening his previous opposition to IMF involvement. This makes it more likely that other eurozone countries will also relax their opposition to the measure.

There are now hopes that in the coming days, the EU might be able to alter the conditions under which it would undertake an emergency rescue, while making it clear that a rescue of Greece would not be automatic.

However, Merkel’s hard-line position remains controversial, with a top European Central Bank policymaker warning that IMF involvement suggested that the euro was a currency that required external support of an international organization to survive.

In an interview with Germany’s Die Zeit newspaper, Lorenzo Bini Smaghi warned that recent market reactions demonstrated that resorting to the IMF “can be detrimental to the stability of the euro.”

At the same time, market sentiment towards the euro has clearly soured. John Taylor, chairman and chief executive of FX Concepts LLC, the world’s largest currency hedge fund told Bloomberg television that the euro would likely drop to $1.20 by August, compared to about $1.33 at present. The euro was trading at $1.50 last December. “There’s nothing really good happening in the euro at all. The economy’s weak and you have the southern European countries falling apart,” he said.

Tensions over sovereign debt were stirred further by an announcement from the rating agency, Fitch, that it had cut Portugal’s credit rating for long-term debt from AA to AA minus, citing the high debt levels in the economy, its weak export performance and the likelihood the country’s economic growth remaining weak.

Slow economic growth, it said, “will put pressure on its public finances over the medium term.” It also noted that Portugal’s budget deficit climbed to 9.3% of GDP last year. “The government will need to implement sizeable consolidation measures from next year, on top of the reversal of the fiscal stimulus this year, in order to meet the 3% of GDP target by 2013.”

This article first appeared on Business Spectator.