I LOVE it when real people get in the way of politicians’ plans. Unless you have been on a very long vacation or involved in a pilot series of ‘Big Brother – the space-station edition’, you will be aware that France and Holland decided to reject the European Constitution.
The politicians tell us that the French and Dutch voters weren’t reflecting their thoughts on the Constitution; they were demonstrating against local political matters. Whether they are right or wrong – and I have a very strong suspicion they are completely aware that they are misinterpreting the results – the twin rejections have cast a very dark cloud over the Eurozone and struck a damaging blow to the euro.
The votes came at a time when the US dollar had finally shown signs of strength after three years of decline and the effect was to push the US dollar down to http://www..81 against the pound and http://www..2150 against the euro. Just a month before the French and Dutch votes, these currency pairs had been flying high but the rates had fallen from http://www..3124 on EURUSD and http://www..9218 on GBPUSD. However, the acceleration after the referendum results had been announced was as impressive as it was costly for those with US dollars to buy.
The dollar’s recovery had been prompted by stronger US employment growth and a sudden and unexpected fall in the size of the US trade deficit. A $55 billion hole in America’s finances would have been a problem at one time but, compared to the worst figure of $61.7 billion, it looks almost manageable. This added to the feeling that US interest rates, already higher yielding than the 2.0 per cent available in Europe, were certain to rise throughout the remainder of 2005. This sentiment however, has been doused in cold water in recent days as the Federal Reserve has been far more cautious in its language; leaving traders to conclude that, rather than US interest rates rising strongly as previously thought, there is a strong chance that US rates may ease higher, level off or even decline before the end of 2005. Certainly the US Bond markets are factoring in lower base rates into 2006.
Nevertheless, the dollar is still looking attractive as the most liquid and most widely traded currency in the world, leaving the pound to bob around in the forex Ocean like a discarded buoyancy aid – floundering in the wash between the rhetoric from EU leaders and US traders’ enthusiasm for the dollar.
The GBPEUR rate has risen as pessimism about the European economy has driven funds from the euro into the dollar and sterling. The Eurozone interest rate has stayed at two per cent for over two years much to the annoyance of the Germans and French; who are facing record unemployment; and Italy with a recession on their hands. All three countries would love to borrow more, spend more and drop interest rates to stimulate growth. They can’t of course as the Stability Pact rules restrict the ability of individual nation states to manage such things unilaterally. Growth is slow in many Eurozone countries and exports are down, so it is not surprising that the first murmurings are being heard of withdrawal from the euro. Is this the mythical ‘Plan B’ that wasn’t supposed to exist?
The coming months are going to be very hectic for the euro as referendums on the proposed constitution are either cancelled, or go ahead in the glare of the world’s media, accompanied by huge amounts of pressure from the EU hierarchy to reach the right (Yes) conclusion. The more concern that is voiced over the European project in general, and the more that withdrawal is mooted, the more intense the pressure will be on the five year old currency. Against this background, the dollar and pound are holding firm and with EU interest rates under pressure to fall, it is likely that the direction for GBPEUR is upward and that the direction for EURUSD is down.