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New slump in euro tests Europe's resolve: Do they really want a stronger currency?

May 13, 2010 |  5:34 pm

Europe’s rescue plan for its weakest member states stabilized the continent’s stock and bond markets this week. But if the goal was to stop the euro’s slide, the rescue is fizzling.

The currency slumped on Thursday for a third straight session, ending in New York at a new 14-month low of $1.253, down from $1.263 on Wednesday.

The euro had jumped as high as $1.309 on Monday from $1.276 on Friday after the European Union announced a plan to lend up to $1 trillion to struggling euro-zone countries over the next three years, if they can’t raise needed cash in the bond market.

But the rebound didn’t hold, and the currency began sliding again by late Monday. The euro’s fall on Thursday -- and the flip side of that decline, which is the dollar’s strength -- was cited by some stock traders as a trigger for the late-afternoon slump in U.S. equities. The rising dollar could hurt U.S. multinational companies and exporters as foreign earnings translate into fewer dollars.

Euromay13 The Dow industrials ended down almost 114 points, or 1.1%, to 10,782.95.

Euro weakness also can be murder on Americans’ foreign-stock mutual funds, if those portfolios are heavy with euro-zone stocks (which many are). German stocks, for example, are up nearly 5% in euros year to date -- but are down 8.2% in dollar terms.

When they announced their rescue plan on Sunday, European leaders talked about the importance of defending the 11-year-old euro. But they also know that allowing the currency to slide further could help their economy longer-term by making their exports cheaper. Germany, in particular, stands to benefit from a falling euro because of its huge export business.

Brian Dolan, chief currency strategist at in Bedminster, N.J., noted that the $1.25 area is where the euro bounced in late 2008 and again in March 2009. So if the Europeans truly want to defend their currency, this could be a crucial moment.

The fundamentals seem to be stacked against the euro. A currency tends to rally when the underlying economy is improving. For Europe, growth was meager in the first quarter and may be harder to come by in the second half of this year if Greece, Portugal, Spain and other deficit-ridden nations follow through on austerity promises.

What’s more, Europe’s debt woes are likely to mean the European Central Bank won’t be in any hurry to raise interest rates. Low rates tend to undermine a currency’s appeal.

“I think we’re going lower on the euro,” Dolan said. He figures the currency will slide to about $1.16 by year’s end, though he says it could get there a lot sooner.

But Dan Katzive, currency strategist at Credit Suisse in New York, thinks the bad news for the euro is nearly all out, unless euro-zone government bond yields resurge. He sees the currency stuck in a trading range of $1.25 to $1.30 for the time being.

In tandem with the European Union’s lending plan, the European Central Bank this week began buying euro-zone government bonds for its own account to calm default worries and push yields lower. By Thursday the yield on the Greek government’s two-year note had fallen to 6.87%, down dramatically from 18.27% last Friday.

That part of the rescue, at least, so far is working as planned.

-- Tom Petruno