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Wednesday December 22, 2004 - 14:40:53 GMT

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ECB intervention unlikely

ECB intervention unlikely

The Euro has risen to a point where it is certainly uncomfortable for the Euro-zone economy, but it is not yet in the danger zone. The ECB will be watching the situation very closely, but the chances of near-term intervention are still low, especially as speculative attacks on the dollar have moderated. There is unlikely to be co-ordinated intervention below EUR/US$1.45 and Asian currency gains would further lessen the intervention threat.

The Euro push to near 1.35 against the dollar has revived calls for the ECB to intervene to prevent further Euro gains. The latest calls came this week from the IFO German economic institute. There has been no evidence of ECB intervention over the past month, although some covert intervention may have occurred.

Is the Euro overvalued?

Evidence from the latest trade figures is inconclusive, especially as the figures do not cover the most recent Euro gains. For the third quarter of 2004, for example, there was an annual increase in exports of 8.7%. The most recent figures for exports to the US also recorded an annual increase of close to 9.0%. Since then, the Euro has strengthened to near EUR1.34/US$ from 1.22 and this will result in greater stresses for the export sector. The latest imports figures also registered a decline in imports from the US which does not suggest that the Euro is overvalued.
In terms of the old dollar/Deutschemark, the current level is around 1.47 which is strong in historic terms, but not massively out of line. A sharp decline in Sterling would increase concerns within the Euro-zone. Conversely, Asian currency appreciation would ease exporter concerns substantially. The overall ECB monetary stance is still accommodative and the deflation fears are low at this stage. Overall, the serious pain threshold for exporters is likely to be above EUR1.40/US$,

Markets not disorderly

Although the markets have been relatively volatile over the past few weeks and the Euro has gained strongly, the markets have certainly not been disorderly. In particular, there has not been a chain reaction of selling within US asset classes. Indeed, US equity markets have performed strongly with the Dow at a 42-month high. The orderly nature of markets will lessen the case for intervention to support the dollar. The speed of the dollarís decline is also as important as the level and there will be much greater tolerance of slow Euro appreciation.

Decline in speculative bets.

There was a record number of speculative long Euro positions during November, but the latest figures have indicated a complete reversal with the markets switching to a short Euro position. This indicates that fears over intervention have been successful in curbing speculation against the dollar. This positioning shift substantially erodes the near-term case for intervention and would also make successful intervention less likely.

High cost of failure

One of the biggest dilemmas for the central banks is that failed intervention is even more damaging than doing nothing. In this context, the ECB will be very wary of intervening on its own. If concerns escalate, there will need to be a co-ordinated effort among the G7 members to stabilise the dollar and make intervention effective. This is unlikely unless the US currency weakens considerably further, especially as there are benefits to the US from a gradual dollar decline. There is also likely to be an acceptance of dollar weakness by European officials as it lessens the risk of a destabilising adjustment in the US and global economy.
The chances of co-ordinated intervention will be much stronger if the dollar weakens to a point, or at a speed, where it starts to destabilise the US assets markets and economy.


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