CONTAGION IS STILL A RISK FOR THE EURO

BORIS SCHLOSSBERG
DIRECTOR OF CURRENCY RESEARCH, GFT

AFter several weeks of tense negotiations and turbulence in the credit markets, Ireland accepted a financial aid package from EU and the IMF. Although the size of the deal will not be known for days, analysts put the total at about €100bn – 40 per cent of the country’s GDP.

By finally accepting the bailout, if the government survives, Ireland will be able to address two critical problems posing an enormous threat to its fragile economy. First, by avoiding the capital markets the Irish government will obtain financing beyond the middle of next year without having to pay punitive interest rates. Second, the Irish banks, which are highly vulnerable to a run on deposits, will receive an infusion of capital. This should hopefully restore confidence and allow balance sheet repair.

Many investors are still worried about contagion as attention shifts to Portugal and Spain. Even as credit default swap rates on Irish debt fell, the rates to insure Spanish and Portuguese bonds rose as concerns grew that Iberia would be the next hot spot.

It’s almost impossible to imagine what would happen if Spain needed financial aid. The country is the fourth largest economy in Europe and would require capital amounts that dwarf any efforts so far. As Barclays’ Henk Potts aptly said: “EU officials may have won the battle, but the war is still to be fought.” Irrespective of the Irish bailout, euro-US dollar is unlikely to maintain its rally unless the economic situation in the Eurozone carries on improving. That’s why today’s IFO report could prove to be the make or break event for the euro this week.

Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read commentary at www.GFTUK.com/commentary or e-mail borisandkathy@gftuk.com.