Euro stalls on O’Neill fiscal proposals

The US economy may be clouded with uncertainty, but the situation in the eurozone will be of little help to the euro, writes Matthew Clements, economist at Prebon Yamane in London

The dollar got the catalyst it needed last week to make significant gains against the euro, with the announcement by US Treasury secretary Paul O’Neill of plans to expand fiscal stimulus proposals in the wake of the terrorist attacks of September 11. The total pledged towards tax cuts, extra spending, and airline rescue could now top $110 billion, subject to Congressional approval. Meanwhile, further rate cuts, a rallying stock market and a tentative improvement in some US economic data are all dollar-supportive in the shorter term.

Consequently, euro/dollar now faces a significant downside risk given the corresponding economic situation within the eurozone. Rising unemployment, falling business confidence and a depressed manufacturing sector within the core EMU economies implies growth divergence with the US going into next year.

Furthermore, the European Central Bank still appears reluctant to ease monetary policy aggressively, despite its own forecasts that see harmonised inflation across the eurozone falling back towards the 2% target level next year. Given the typical time-lag of 6--12 months for monetary policy to have its full impact, the ECB’s stubbornness is even more perplexing.

The Byzantine nature of monetary policy decision making with the governing council means the ECB lacks either the transparency provided by the Bank of England’s MPC meeting minutes or Greenspan’s communicative rapport with the markets. The impact this has on the euro is difficult to quantify, but it is unlikely to be doing it any favours.

The euro’s sensitivity to the changing US economic outlook was highlighted by euro/dollar moves relative to the Federal Reserve’s major-currencies-dollar-index in the weeks after September 11. As well as showing predictably greater volatility, euro/dollar made steeper gains in percentage terms, some of which the currency has also managed to hold onto, while the broader index is now returning to its pre September 11 level.

matthewc@prebon.co.uk