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Europe's currency could make or break the recovery

Europe's currency could make or break the recovery

The euro has enjoyed a near-10% rise against the US dollar since August 2012. This has put pressure on the margins of many companies operating predominantly in euros.

Although the rise indicates positive sentiment towards the region, some managers believe a prolonged period of currency strength could have a negative impact on the eurozone’s recovery, while others believe the ECB will do whatever it takes to halt the currency’s march.

Others, meanwhile, argue the near-ubiquitous internationalisation of production means the strength of the currency doesn’t have nearly the impact it would have done in years gone by.

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Rising price pressure

Citywire + rated Richard Pease says the rise in the euro has contributed to a deterioration of price and cost competitiveness for European exporters.

‘At the same time, high unemployment levels (12.1% in October 2013) have pushed down labour costs.'

'Firms have been able to discount prices in an effort to offset squeezed profit margins, but this in turn has put downward pressure on the rate of inflation. The risk comes if this weakening inflation turns into deflation, where prices persistently fall.’

Currency still too weak?

Citywire + rated Stuart Mitchell is not overly concerned by the recent strength of the single currency, and argues it could go higher yet.

He told Citywire Global: ‘We think that the effects are exaggerated. In contrast to 20 years ago most large eurozone corporates have diversified production abroad to match sales.'

'Secondly, the eurozone continues to run a trade surplus and the recovery appears to be accelerating despite the recent strength of the currency. Germany still has a very significant cost competitive advantage relative to the rest of the developed world.'

'We can see this in the continuous market share gains made by the industrial sector. Arguably the currency is still too weak.’

Expect policymakers to step in

Citywire AAA-rated Dean Tenerelli believes the strengthening of the euro should be viewed as a sign of confidence in the region, not only in its long-term sustainability but also in the encouraging current structural and economic progress.

He told Citywire Global: ‘The currency strength should be expected to have some adverse competitiveness effect on European companies, although better quality companies will be better placed given their product and pricing strengths.'

'However, I believe that European policymakers are very mindful of not allowing any further euro strength to derail the current recovery, and policy actions are likely to be forthcoming if we see renewed strength from here.’

This article originally appeared in the February issue of Citywire Global magazine

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