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If political will is the glue holding the euro together then euro-zone politicians had better start talking fast.
Since the start of the year, the problems of the euro zone’s peripheral debtors have had little impact on the single currency.
Financial markets had been convinced that, come what may, there was enough resolve in the region’s political community to ensure that a solution will be found.
So, even though the debt servicing costs of some peripheral debtors continued to rise and insurance premiums for holding their debt became nearly prohibitive, the euro itself remained strong–taking its cue more from the hawkish stance of the European Central Bank and the outlook for higher euro-zone interest rates instead.
But all this has changed in the last few days.
First, the ECB surprised investors by proving less hawkish than expected. This coincided with a crash in commodity prices that helped the dollar and sent the euro into one of the steepest dives it has faced in the last two years.
If that wasn’t enough, the single currency then faced even more damaging news.
Finance ministers of several euro-zone countries held an essentially secret meeting over the weekend to discuss Greece. Reports that Greece is considering pulling out of the euro were denied, but Eurogroup leader Jean-Claude Juncker was forced to concede that Greece does need a further adjustment program to kick in next year, above and beyond the â?¬110 billion negotiated last year.
For euro investors, who were already struggling as yield differentials moved against the single currency, there is now evidence that the political will that has helped to keep the euro together for so long is once again under strain. With Greece seeking more funds, the success of Ireland’s and Portugal’s bailouts will likely come into question and the risks of further contagion to Spain will be that much more likely.
This is the last thing euro-zone politicians will need as they struggle to keep their own fiscal houses in order and their own political standing from plummeting.
In other words, the political will to keep the euro could be starting to ebb as the costs of the enterprise continue to rise.
For the euro, this is bad news in more ways than one.
Renewed concern about the peripherals will increase pressure on the ECB to take an even more considered approach to interest rate rises and speculation that the central bank will increase rates again as early as July could well retreat. Then there is the issue of diversification. The single currency has received considerable support in recent months from central banks diversifying their foreign exchange holdings out of the dollar.
However, if the future of the euro is once again being seen in political doubt, these flows could well be suspended as central banks seek the more stable environment of more high risk currencies such as the Australian and Canadian dollars. At the moment, the euro may be consolidating, as investors lick their wounds after that sharp six-cent fall sustained last week.
With long speculative positions in the euro reaching a four-year high just before the fall, this pause is hardly surprising. But, the large scale of long positions could also prove damaging, especially if more speculators lose faith in the political support for the single currency and start to pull out.
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The Source is WSJ.com Europe’s home for rapid-fire analysis of the day’s big business and finance stories. It is edited by Lauren Mills, based in London.
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