Editor's note

Continuing uncertainty in the eurozone posed investors in Europe with the main question: how much further the currency could fall. During the last decade of strong European growth, the common currency produced a rising credibility, making the euro as the most popular reserve currency after the dollar. Hence, central banks around the world and in Europe diversified their reserve holdings at the expense of the dollar.  

Diversification of global reserve holdings has been a source of support for the euro in recent years as central banks have sought to adjust their portfolios away from the dollar.

Some say, that China’s $2,450bn of foreign exchange reserves is to about 20-25 per cent held in euros, compared with 60-65 per cent in dollars. Figures from the IMF show that foreign euro reserves outside China rose from $ 97 bln in the first quarter of 2002 to $ 672 bln in the fourth quarter of 2009. The latter figure was out of total stockpiles of $ 2,180 bln.

Source: Garnham P. A currency not just single but unloved. –Financial Times, 11 May, 2010.

Experts say, however that the euro’s recent break below $1.30 against the dollar is likely to exacerbate worries over its status. The rescue package has given rise to serious longer-term concerns over euro, which could reduce the global demand for single currency.

European politicians, e.g. the French president, suggested that the aim of the rescue package was to stop the “speculative attack” on the euro.

Crisis management and euro

Analysts say that the short-term speculators are presently at the sidelined, while actions of longer-term investors would dictate the single currency’s discretion.

Besides, the sovereign reserve managers in Europe are worried over the unpredictable and uncertain crisis-management capabilities among the eurozone institutions during spring time in 2010. Even with the “impressive bailout”, it did not appease the concerns of many longer-term sovereign investors, said experts at UBS. Moreover, euro could fall even further on when long-term investors decide to abandon the euro as a reserve currency. The problem is that the European bond markets have ceased to be a homogenous entity reducing its attractiveness to foreign investors.

Positive weak euro

Analysts say that the rescue package was aimed at stabilising government bond spreads in the eurozone and providing stable funding conditions in Europe.

The bottom-line is that a weak euro will benefit the eurozone’s economy, as it should increase exports and help countries to mange their substantial budget deficits and rising debts.

This message was based on the latest European Central Bank’s announcement of perspective acquisition of euro-zone sovereign debt, in fact a U-turn from its previous position. One reason the euro had performed relatively well until this year was the fact that the ECB had refused to follow the Federal Reserve and the Bank of England down the path of quantitative easing, QE.

Analysts say that the ECB’s reintroduction of its long-term financing operations, will provide new fixed-rate loans to banks and will positively affect euro-zone’s monetary policy.

On the other hand, the euro-zone’s finance ministers this weekend generally argued that they acted to save the euro. It seems in reality that their main intention was to save national bond markets. If the ministers wanted to “save” the euro, they would have tightened monetary conditions; they have been loosened, in fact.

Some even voiced a scary thought that if there was not a euro crisis before May it might come to politicians’ agenda presently.

As to the Baltic States, the tougher control for monetary and economic development in the three countries might be the greatest challenge towards their passage to the common currency.