The New York Times

June 21, 2005

Euro Tumbles Into Void Left by Continent's Rifts


FRANKFURT, June 20 - As European leaders bicker over money and the future of their union, the main victim is proving to be the euro, their sturdy but still sensitive young progeny.

The six-year-old currency fell sharply in trading against the dollar on Monday in the aftermath of the failure of the European Union summit meeting Friday.

It was the latest tumble for the euro, which has swooned since France voted against the European constitution last month, throwing Europe into political turmoil and raising questions about the long-term stability of its monetary union.

The euro has fallen 3 percent against the dollar since the French referendum, and more than 10 percent from its peak at the end of 2004. On Monday, it traded at $1.214 in New York, a decline of 1.1 percent from Friday.

Monday's decline was hastened by new rumors that the European Central Bank was considering a cut in interest rates to try to resuscitate the Continent's languishing economies. In this jittery environment, analysts said, traders are seizing on anything as further evidence of the euro's weakness.

"We're in the eye of a storm," said Nicolas Sobczak, senior European economist at Goldman Sachs in Paris.

The convergence of negative factors has shifted the dynamics of the currency market. The euro usually trades up and down in response to the dollar and the American economy, analysts say. Its rise over the last year is generally viewed as a barometer of the dollar's weakness, rather than the euro's intrinsic strength.

Now, however, the euro is being driven mainly by European events - few of them positive. It rose slightly on Friday when the United States reported its current-account deficit, but promptly resumed its slide after the summit meeting's attempt to hammer out a budget ended in acrimony on Friday.

"We're in a very pessimistic mood," said Michael Schubert, a currency analyst at Commerzbank in Frankfurt. "It's a herd instinct. Everybody is looking for factors against the euro and in favor of the dollar."

He and other analysts expect the euro to regain traction eventually, and make up some of the ground lost against the dollar, which remains burdened by an enormous current- account deficit in the United States, $195 billion in the first quarter. Mr. Sobczak of Goldman predicted that after a further decline to $1.15, the euro would rebound to somewhere between $1.25 and $1.30.

Still, he said, the fallout from Europe's political strife had been more severe than analysts expected. "We didn't think it would affect the euro that much, and that sentiment would turn so bad."

Adding to the uncertainty are strident voices in Europe declaring that the euro is a failure, and should be scrapped. While those calls have so far been limited to populist leaders in Italy, perhaps the most economically fragile country in the euro zone, they are sowing unrest about the currency's stability.

With 10 new countries in Central Europe applying to adopt the euro, analysts said the currency was at a delicate moment in its development. These countries remain generally enthusiastic about the euro, but a drumbeat of negative publicity could weaken their resolve, particularly in places like the Czech Republic, which has already said it was in no hurry to convert its currency.

"If the 'no' vote, and the rancor over the budget, starts to undermine this vision of Europe and the euro, you could see the new countries reappraising the process," said David Abramson, the head of European research at BCA Research in Montreal. "Then what does the euro become?"

Mr. Abramson said he was particularly concerned about Italy, which has diverged radically from its neighbors in economic performance. With a damaging loss of competitiveness against Asian and even European countries, its exports have dried up and its economy has fallen into recession. Historically, Italy would have reacted by devaluing its old currency, the lira.

Deprived of that opportunity by its membership in the euro zone, Italy faces a painful adjustment that some analysts fear could stir political unrest and turn even more people against the euro. Greece and Spain face similar losses of competitiveness, which could hobble their future growth.

Europe's generally anemic performance has enormously complicated the task of the European Central Bank. It faces mounting political pressure to cut interest rates. And though its president, Jean-Claude Trichet, insists it will hold the line, bank watchers sense a weakening in its resolve.

"You can't separate the political crisis from the rumors about a rate cut," said Jörg Krämer, chief economist at the HVB Group in Munich. "A rate cut is perceived as something that would help the political crisis. It may ease the situation."

To currency traders, rumors of a cut are yet more evidence of Europe's - and therefore the euro's - weakness. But to European exporters, a weaker euro would be a welcome reprieve, even if fleeting, because it would reduce the cost of their goods in the United States and other markets.

Indeed, far from lamenting the recent decline in the euro, politicians in France and Germany seem comforted by it. "The exchange rate has reached a level that is more in line with reality," Prime Minister Dominique de Villepin of France said in a speech last week in Paris.