Euro Parity With Dollar Only A Matter Of Time Now. By Nicholas Hastings

The euro has become a risk too far and it is now only a matter of time before the single currency sinks to parity against the U.S. dollar.

The euro is set to suffer because of continued uncertainty over the ability of euro zone states to reduce their deficits and from the economic and political fallout from the whole sovereign rescue plan.

Until now, the single currency was being sold primarily because of the rising borrowing costs that euro zone debtors--primarily Greece, Spain and Portugal--were facing as the European Union and the International Monetary Fund negotiated a bailout.

This bailout is now in place and yields have stabilized. But, selling pressure on the euro has, if anything, intensified.

See the euro's recent decline against the dollar:


Click Image to Enlarge


First, there is concern over just how long the governments of these debtor countries will persist with austerity policies in the face of strikes and civil unrest.

Given the current structure of the European Union, there is little that other member states can do to force them to stick to deficit rules, other than to kick them out of the single currency bloc and risk a collapse in the euro.

Then, there is the actual fallout from the bailout.

Economically, not only debtor countries will suffer from the plan. They may be the ones implementing the harshest austerity measures but other euro zone countries, who are providing funds for the bailout, will do so at a cost to their own troubled economies.

Also, euro zone banks are hardly likely to help. If a European Central Bank warning is right, they could face another EUR200 billion of writedowns over the next 18 months, damaging their funding costs and keeping credit conditions in the euro zone tight.

In other words, the growth prospects for the euro zone, which were already poor before, are now looking even worse.

Euro zone interest rates are now set to stay at current low levels for even longer than expected.

This is hardly likely to play well in comparison with the dollar and the U.S. economy. As new employment numbers on Friday are expected to show, the U.S. recovery may be vulnerable to setbacks but a rise in non-farm payrolls will suggest that growth is finally gaining traction in the jobs market.

Compare this with the latest euro zone employment data Tuesday, showing the number of jobless in the region rose by another 25,000 in April, taking the unemployment rate up to 10.1%, nearly a 12-year high.

Possible political fallouts are also a growing problem for the single currency.

The political pressure that euro zone debtor governments are facing is one thing, but it is the impact on the politics of Germany that really matters.

German Chancellor Angela Merkel has already paid a high political price for agreeing to the bailout and now, following the resignation of German President Horst Kohler, she could find her coalition is falling apart if small liberal partners refuse to sign up to tax hikes needed to fund the country's larger deficit.

But politics could also affect the ECB, where the central bank's recent decision to buy government bonds to help stabilize yields and prevent contagion isn't too popular.

Some officials are worried about the damage this additional policy easing will have on the central bank's credibility with Bundesbank President Axel Weber warning that any further purchases should be "limited."

All this suggests that the euro's role as a funding currency is here to stay and that the single currency won't be able to stage a sustainable recovery even when global sentiment improves and risk once again become more popular.

The risk of buying the euro will still be seen as too high.

Early Wednesday in Europe, the euro continued to sink against the dollar, falling to $1.2206 by 0645 GMT from $1.2237 late on Tuesday in New York, according to EBS.

The yen was under pressure after Japanese Prime Minister Yukio Hatoyama resigned before Upper House elections next month. Finance Minister Naoto Kan is widely tipped to replace him on Friday but this could leave the yen under pressure both because Kan has suggested that he prefers a weaker currency and because there will still be uncertainty over how the government fares in the elections.

The dollar rose to Y91.47 from Y91.11 while the euro made it up to Y111.72 from Y111.44.

Overall, market sentiment has been boosted by a strong manufacturing ISM survey out of the U.S. Tuesday and news earlier Wednesday that Australia first quarter growth came in higher than expected at 2.7% on the year. The market had been looking for only 2.4%.