Global investors are favouring European currencies as the long-laggard continent ascertains its strong economic growth and the US economy shows signs of a substantial slowdown. But this may not be good news for all.
The euro rose to a two-year high of $1.3613 on 18 April – just half a US cent below its all-time record of $1.3667 in December 2004 – after a survey showed German investor confidence rising for the fifth consecutive month, beating analysts’ expectations.
At the same time, the pound broke the $2 barrier for the first time in almost 15 years, as a new government report showed that the cost of living in the UK had surged significantly more than expected in March.
The country’s 3.1% consumer inflation rate is more than 1% over the Bank of England’s target of 2% and strengthens the likelihood of the Bank pursuing another interest rate increase, from the current 5.25% to 5.5% – the fourth three quarter-point rate hike since August.
Higher interest rates, used to combat inflation, typically strengthen currencies by attracting more investors.
The European Central Bank (ECB) has also been raising its rates over recent months while the US Federal reserve has held the cost of borrowing steady.
Expectations of further monetary tightening in the eurozone (with a rate hike from 3.75% to 4% expected by the ECB in June), coupled with muted expansion in the US since the end of 2006, have led investors to invest more heavily in euro assets.
The downside is that the strong euro could put a brake on European exports – making a serious dent in EU companies’ earnings – as goods become more expensive and the eurozone loses competitiveness both against the US and countries such as China and Taiwan, where currencies are closely linked to the dollar.
But, on a more optimistic note, figures published on 17 April by the EU’s statistical agency show eurozone exports to have grown by 11% over one year.