Cheap Money

Despite Crisis, Euro in High Demand

bb_006_70118288 (39118/BB_006_70118288), Kassalade, (© INSADCO / Bilderbox)
The euro is popular in carry trades.
  • Why it matters

    Why it matters

    The euro is becoming increasingly attractive as a financing currency, as low interest rates allow investors to borrow money cheaply in euros to finance riskier investments in other currencies.

  • Facts

    Facts

    • Investors have observed over the last year that share prices have tended to move in the opposite direction to the euro, with the value of the common currency rising when Germany’s DAX index falls and vice versa.
    • A comparison of purchasing power shows that the euro is undervalued by almost 16 percent against the dollar.
    • The euro is expected to remain attractive as a financing currency for some time, given that interest rates in the euro zone look set to remain low in the medium term.
  • Audio

    Audio

  • Pdf

The European Union had barely reached a last-gasp agreement with Greece to hold negotiations on a new rescue plan, keeping it in the continent’s common currency, when the euro abruptly plummeted in value.

Within just a few days of the marathon talks in Brussels in mid-July, the euro slipped from $1.12 to $1.08. It remains around that level today, having risen only slightly to trade above $1.09 on Friday. What is particularly odd is that the euro has continued to decline even as stocks in Europe have recovered (see graphic below).

The decline in value has raised some tough questions for the 16-year-old currency bloc, which includes 19 countries ranging from Ireland to Latvia. Is the euro degenerating into a soft currency? Is Europe turning into a transfer union, where richer members constantly have to bail out their poorer peers, combined sluggish economic growth in all member states and a common currency that is constantly weak?

But for others, it’s a sign of a rather bizarre trend that could actually keep the currency from collapsing further: “Bad news supports the euro, while growing confidence has an adverse effect on it,” said David Kohl, an expert at the Swiss private bank Julius Bär.

The reason is that, due to record the low interest rates in Europe, the euro is becoming a financing currency for projects in other countries. It means that in times of crisis, investors are likely to buy – not sell – additional euros in order to pay off their growing debts from these foreign investments.

A comprehensive study by German cooperative bank DZ Bank confirms that the euro is becoming increasingly important as a financing currency, along with the Japanese yen. As evidence of this, the bank points out that a growing proportion of new issues by international debtors being denominated in euros. Their share in all new issues rose by 9 percentage points in 2014, reaching 29 percent at the end of the year.

The euro, in short, is growing up. It’s a dynamic that might explain why the euro hasn’t plummeted further, despite the many predictions that earlier this year that the euro was doomed to weaken.

Want to keep reading?

Subscribe now or log in to read our coverage of Europe’s leading economy.