The meltdown in the euro - it has plunged 18.5 per cent against the U.S. dollar in the past six months - reflects disarray in the euro zone and lack of prompt and a unified response, strategists say.
While the almost $1-trillion (U.S.)_bailout package by the European Central Bank and International Monetary Fund has failed to halt the slide, the euro is not about to go extinct, analysts at Credit Suisse Group said.
The risks of defaults are significant, "unless and until rules for a more explicit fiscal and political union within the euro zone are worked out," it said. "This process has now begun in a classic process of crisis-led reform."
The European authorities have "bought time - a lot of time - to negotiate a new fiscal union by preventing a liquidity and funding crisis for both peripheral sovereigns and European banks."
In fact, the risk of default by Greece based on credit default swap spreads suggests the chance of default is being overpriced and distorted by political risk, Credit Suisse said in a report Tuesday. "History suggests countries with floating currencies, independent central banks, and domestic currency debt have negligible credit risk," the report said.
To put the bailout package into perspective, Canaccord Capital Inc. calculated that it amounts to 77 per cent of the government debt for Greece, Spain and Portugal, in its daily "Morning Coffee" publication Tuesday.
"Admittedly, if the EU were to break up … the consequences would be huge," according to Canaccord.
Greece, Spain, Ireland and Portugal have external debt equal to about 86 per cent, 97 per cent, 55 per cent and 92 per cent of their gross domestic product, respectively, it said. If Greece were to default on one-third of its debt, foreigners would have to write off $115-billion of Greek government bonds and banks would face a $78-billion charge, according to Canaccord.
"Clearly, if Spain, Portugal and Greece were to default together with a 33-per-cent haircut, then ... global banks would have losses of $550-billion," Canaccord said. That compares with the $1.8-trillion of write-offs for all financial institutions since the start of the credit crisis.
But the plunge in the euro probably reflects the economic realities and will help boost the competitiveness of the euro zone as it faces the economic problems ahead.
"I don't think it's really panicky today," said Shaun Osborne, the chief currency strategist at TD Securities Inc. "We haven't seen signs of panic selling."
The euro tested the lows of last week and the euro zone continues to face sovereign debt and bank issues. "Europe is on the defensive and it is likely to remain so," he said.
Nevertheless, Mr. Osborne does not expect intervention in the currency markets by the ECB unless the market shows signs of being disrupted by a lack of liquidity. "I don't think they are too worried by the level," he said. "They are probably concerned by the pace of the decline."
The drop in the euro brings the currency closer to its fair value compared with what it has been and will help the countries deal with the fiscal austerity challenges, which will undermine the growth outlook for Europe, Mr. Osborne said.
"Based on what we see, the trading is consistent with an orderly market," said Joe Manimbo, a currency market analyst with Travelex Inc., which is engaged in foreign exchange services. "Other issues are dogging the currency. European leaders don't seem to be on the same page as to what needs to be done to deal with the financial crisis," Mr. Manimbo said. Some sort of unity would go a long way to stabilizing the market, restoring confidence and reduce investor speculation, he said.