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Monday, May 17, 2010 12:39 PM UTC

Euro slides amid Euroepan debt crisis

The euro hit a four-year low against the dollar despite financial rescue package unveiled last weekend

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Topics: European Financial Crisis, European Union,

The euro fell further from grace Monday, hitting a four-year low against the dollar amid growing fears European governments won’t be able to keep a government debt crisis from damaging the continent’s economy.

By early afternoon, London time, the euro was trading 0.3 percent lower on the day at $1.2320 as finance ministers from the EU gather in Brussels to try to restore confidence and ward off a full-fledged financial meltdown.

Earlier the 16-country euro had fallen to $1.2237 — its lowest since April 2006 — meaning it had fallen nearly 10 cents in the space of a week.

The shared currency has now fallen a staggering 12 percent over the past week in spite of the massive euro750 billion ‘shock and awe’ financial rescue package unveiled last weekend from the EU, together with the International Monetary Fund.

The slide comes as Europe’s leaders are saying that the loan backstop isn’t enough and that goverments must take drastic steps to get debt under control — and shore up the fundamental rules that govern their 11-year-old currency.

German Chancellor Angela Merkel conceded over the weekend that package was no more than a band-aid solution to the problems afflicting a number of eurozone countries, from Ireland all the way across to Greece.

The solution, according to Merkel, is greater cooperation in financial and economic policy across Europe to ensure the currency’s long-term stability.

European Central Bank President Jean-Claude Trichet echoed Merkel when he told German newspaper Der Spiegel that the package “bought time, nothing more” and that there is now a need for “a quantum leap in the governance of the euro area.”

The package — on top of an earlier euro110 billion bailout of Greece — appears to have calmed fears of immediate disaster — such as a wave of debt defaults across the 16-country eurozone — but longer term issues remain.

In particular, investors remain highly skeptical about the ability of Europe’s governments, Greece’s in particular, to push through the austerity measures promised in the face of likely political and social unrest. And even if they do, there are fears the cutbacks will kill off growth — and make it even harder to pay government debt.

“This week has started with the news that the German government will press other eurozone countries to follow its example in setting rules for balancing budgets within its regions,” said Jane Foley, research director at Forex.com.

“However, this is unlikely to fundamentally alter sentiment with respect to the euro given broad based skepticism about the ability of Greece to stomach the budget reform already on the table,” said Foley.

This skepticism has been evident across the financial system. While the euro has dropped sharply, interbank lending rates have spiked higher amid concerns that the debt crisis will prove to another headache for the banking sector. Gold is back in demand as investors seek sanctuary in this traditional safe haven asset — on Friday, gold prices struck a new record high of $1,249.40 an ounce.

Despite its decline, the euro still remains above its average of $1.18 since its creation back in 1999 and a number of analysts think that the selling has been overdone. They think the currency may experience a temporary near-term rebound as traders buy euros to settle recent deals.

That respite could be short lived given worries about the economic impact of the budget cuts outlined in Portugal and Spain, as well as Greece.

“The severe nature of the austerity measures being imposed on countries in exchange for bailout cash has caused a crisis of confidence about future growth levels, and could well precipitate the debt defaults it was designed to avoid,” said Michael Hewson, an analyst at CMC Markets.

Alongside these fears, investors remain worried that the European Central Bank’s independence has been tarnished by the news that has agreed to buy government bonds in the secondary markets to maintain liquidity and keep yields low. Just ten days ago at the monthly rate-setting meeting, Trichet had said the issue had not even been discussed.

The bank has been at pains to say the measure will not increase the supply of money in the economy — a potentially inflationary move.

The euro’s slide has been propelled by predictions the bank will wait even longer before raising its key interest rate , now at a record low of 1 percent. Those low rates can weigh on the euro’s exchange rate by reducing return on euro-denominated investments — especially if rates go up first in the United States as its economy recovers. UniCredit economists have moved their forecast for the first ECB rate hike from March 2011 to the fourth quarter of that year.

(This version CORRECTS Corrects typo in headline. Moving on general news and financial services.)

More Pan Pylas.

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