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Is the Euro Out of the Woods?

September 21, 2010
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It has now been more than three months since the EU, the IMF, the European Central Bank, and EU member states announced their €750 billion bailout package for the Greek government.  Since then, the markets appeared to have calmed down, and worries about a Greek default have decreased.  This has helped the euro rebound against the dollar, as shown in the below graph.  As a result, today all three of the bond rating agencies gave their highest rating to the European Financial Stability Facility (the EU portion of funds to assist Eurozone governments in need).  In fact, European leaders have even started debating how to prevent such a threat to the euro from materializing in the future.

However, despite this good news from the rating agencies and the euro’s increased value versus the dollar, lingering doubts about the euro remain.  For instance, the spread between German government bonds (which are considered the benchmark for all government bonds denominated in euros) remains much lower than that of other Eurozone members, in particular Greece, Ireland, Portugal, and Spain.  Ireland raised €1.5 billion today through the sale of bonds, despite the yield on its 10-year notes rising to 6.56% on Monday, or more than 4% points above the German yield.  At the same time, Portugal’s yield increased to 6.35%, and Greece now stands at 11.44%.  As the figure below shows, the spread between the yield of a 10-year Greek bond and that of a German bond is close to the level it was back in May before the EU organized a bailout.

Source: Calculated Risk

The question thus remains, what will be the outcome of this gap in bond yields?  Some analysts wonder if the result will be that certain Eurozone members will see their credit rating continue to fall, at least in the short term.  Greece, Portugal, and Spain all saw their credit rating downgraded last week, which no doubt helped increase the yield of their bonds this week, which in turn makes borrowing more expensive for these governments.  These lower bond ratings and increased bond yields then caused European stock markets to decrease yesterday, which helped spur American stock markets to also decline.  The good news is that in the longer term, European banks appear to be predicting that the yields will narrow until distance between the four countries’ highest yields and German bonds will be 2.2% or less in two years, down from an average spread of 4.61%.

To understand the implications for Indiana and Midwest, the Indiana University European Union Center will be sponsoring the “The Euro and its effects on the Midwest” in Indianapolis on November 18, 2010.  For more information, please visit the EU Center’s webpage.

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One Comment leave one →
  1. eubeyer permalink
    September 23, 2010 12:43 pm

    For people interested in a more in-depth analysis of the euro and ideas to reform the Economic and Monetary Union (EMU), the Economist has two articles on this topic:

    “Fixing Europe’s single currency” (http://www.economist.com/node/17093339)

    “Trial of strength: Will today’s currency interventions hurt or help the world economy?” (http://www.economist.com/node/17093549)

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