Euro loses bounce from $1 trillion bailout

[May 13, 2010]  LONDON (AP) -- The euro soared after the EU announced a startling $1 trillion financial rescue package earlier this week. But that respite has evaporated -- a sign that worries remain about the heavy debts burdening European governments.

The euro was back near 14-month lows Thursday, at $1.2586, down 0.3 percent on the day. That puts it within a cent of where it was just before rumors of the bold European Union move swept the market.

The euro spiked to a high of $1.3048 on Monday, when the package of loans to be made available if struggling countries need them was announced after frantic talks into the early hours. Policymakers breathed a sigh of relief that their "shock and awe" package had helped to shore up confidence in the shared currency.

Though the package has helped ease concerns of a wave of imminent debt defaults within the 16-country eurozone, currency traders are realizing the underlying problem has not gone away -- how are the highly indebted countries going to get their public finances under control?

In particular, there are acute worries that the Greek government -- however sincere it is -- will just not be able to push through the draconian measures it has agreed to in return for an earlier, euro110 billion rescue over three years, given the likely political and social unrest.

"The government will be attempting to implement nothing short of a cultural revolution amidst a depth of feeling that will not be assuaged with ease -- if at all," said Neil Mellor, senior currency strategist at Bank of New York Mellon.

Those fears are unlikely to have been eased by comments made by Argentina's President Cristina Fernandez, who reportedly said earlier this week that the bailout will fail as the measures were a replica of the "recipes they applied to us, which provoked 2001" -- a reference to the world's biggest sovereign debt default, by Argentina.

Alongside the lingering default fears, there are also questions regarding the European Central Bank's new role of buying government bonds in the secondary markets to maintain liquidity and keep yields low. It's clear that the German Bundesbank's president, Axel Weber, is not too enamored with the bank's new responsibility, as it could stoke long-term inflationary pressures and leave the bank's balance sheet exposed to pretty worthless government bonds. Weber also sits on the ECB's board and he's considered the favorite to replace Jean-Claude Trichet as the ECB's head next year.

Alongside last weekend's euro750 billion support package for the eurozone, policymakers effectively rewrote the European Central Bank's rule-book with the ECB decision to buy government bonds -- just a week ago at the monthly rate-setting meeting, Trichet had said the issue had not even been discussed.

There are also mounting concerns that Germany, the eurozone's biggest country, will also have to undertake some cutbacks itself as it absorbs its share of the cost of the rescue deal. That will hardly get the thumbs-up from a skeptical public that last week inflicted a defeat on Chancellor Angela Merkel in an important regional election.

"This highlights the longer term negative impact on the eurozone with severe fiscal tightening likely throughout the EU and not just in the periphery countries," said Ian Stannard, currency strategist at BNP Paribas.

Meanwhile, it's become abundantly clear that the recovery from recession in the eurozone is proving to be slow -- figures showed that the eurozone economy grew by a tepid 0.2 percent in the first quarter of the year from the previous quarter, compared with an equivalent rate of 0.8 percent in the U.S.

Some near-term pickup is expected as global trade perks up and Europe's high-value exporters gain ground in the wake of the lower euro, which will help boost exports, all other things being equal.

But the longer-term picture is less rosy as governments cut spending and raise taxes to relieve their debt problems -- which will remove government stimulus from the economy and could undermine growth further.

As a result, traders think it's more likely that the European Central Bank, which sets interest rates for the currency bloc, will be one of the last major central banks to start raising interest rates. That's a minus for the euro, since one of the main long-term drivers to currency rates is the interest rate holders get. If the U.S. Federal Reserve starts to raise interest rates, that makes it more attractive to hold dollars -- rather than euros.

[Associated Press; By PAN PYLAS]

Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.