Euro wraps up its best year

The market is infatuated with the euro which rose to $1.2450. Richard Blackden reports.

THANOS Papasavvas was an economist in the British government between 1992 and 1994 as then prime minister John Major decided to keep Britain out of the euro.

Now, Papasavvas is among investors responsible for helping the 12-nation currency surge to a record $1.2450 by selling dollars and buying euros in his job managing currency risk for Credit Suisse Asset Management in London, which oversees $310bn of assets.

The euro has had the best 12 months since its debut five years ago after rising more than 18% against the dollar. The currency Nobel laureate Milton Friedman said in 2001 was a "big mistake", climbed to a record as the European Central Bank kept interest rates higher than the US Federal Reserve.

"In 1999 people were very sceptical," said Papasavvas. "The ECB has now given the currency credibility and the euro has made a strong recovery." The currency's advance has done little to help Europe's economy, which grew 0.4% in the third quarter, compared with an 8.2% annual rate in the US. Heineken NV said its profit will barely increase this year, as the euro's rise erodes revenue. Anheuser-Busch Cos. and Adolph Coors Cos., two of the three largest brewers in the US, reported gains in third-quarter earnings.

Demand for the euro may increase further after the Fed this month said it can keep US rates low for a "considerable period".

ECB officials, whose target rate is twice the Fed's 1%, said they're not ready to stop its ascent. "The current level of the exchange rate corresponds to its long-term average," ECB chief economist Otmar Issing said in a TV interview with Bloomberg News.

"It is essentially back to where it started."

By letting the euro climb, overriding the concerns of politicians such as Italian Prime Minister Silvio Berlusconi, the ECB may jeopardise economic growth next year. German exports, which account for a third of Europe's largest economy, fell the most in more than a decade in October. Italian business optimismdeclined this month. The exchange rate is "very high," Berlusconi told reporters on December 16, according to Italian news agency Radiocor. "This is one of the factors that is hurting so much the countries that export."

UBS AG and Goldman Sachs Group Inc. predict the euro will extend its gains next year. UBS, the world's largest currency trading bank according to Euromoney magazine, predicts the euro will advance to $1.32 by the end of 2004. Goldman Sachs analysts expect it to reach $1.30 in six months.

The culmination of 50 years of European economic integration that began after World War II, the euro has gained in 2003 against 11 of the 16 other major currencies tracked by Bloomberg including the British pound and Swiss franc. Professor Friedman, aged 91, didn't reply to requests for comment by e-mail or respond to telephone messages left at his office at Stanford University in Palo Alto, California. Mr Major didn't return calls seeking comment.

Only the South African rand, the Australian, New Zealand and Canadian dollars, the Brazilian real and the Swedish krona have outperformed the euro. By contrast, the dollar is down against every major currency except the South Korean won and the Mexican peso.

"This really is the euro's year,' Robert Hormats, vice chairman of Goldman Sachs International and a former US assistant secretary of state, said December 18 in a televised interview with Bloomberg News. "It's not quite rivalling the US dollar, but it's becoming a more important reserve currency." Central banks held 18.7% of their reserves in euros last year, up from 16.4% in 2001, according to figures published last month by the International Monetary Fund.

The proportion of holdings in dollars dropped to 64.5% from 67.5%. Foreign central banks have been purchasing Treasuries with the proceeds of their currency sales. The New York Federal Reserve's holdings of US government securities for foreign central banks rose to a record daily average $841 billion in the week ended December 17.

The purchases have helped finance the largest US budget deficit, which increased to $374.2 billion in the fiscal year that ended on September 30, a record 3.5% of the country's gross domestic product. At the same time, the US current account deficit was at $135 billion in the third quarter the third largest on record.

The "double deficit' in the US means there is potential for the euro to extend its advance, said Theo Waigel, who was German finance minister when European leaders agreed to create the euro and is now an adviser to Texas Pacific Group, a US buyout company.

After debuting at $1.17 in January, 1999, the euro tumbled to a low of 82.28 US cents in October, 2000. Only purchases by the ECB in October lifted the currency from its lows. A month earlier, the Fed, Bank of England and Bank of Japan joined the buying.

"The market is infatuated with the euro right now," Robert Sinche, head of global currency strategy in New York at Citigroup Inc., told Bloomberg News on December 17. Traders "aren't going to do anything about it until the ECB cuts rates or the Fed begins to raise them."