Now is the time to think of a stronger €

Much to the market’s relief, war has finally begun. Investors always assume risk when they purchase an asset, but in normal circumstances, they can quantify that risk.

Yet war, with its multiple potential outcomes, is an unquantifiable risk, and that makes investors

nervous. But now that the campaign is underway, investors can finally see an end to the recent period of uncertainty and volatility.

And so far the markets have behaved predictably. The price of oil has fallen, despite the news that some oil wells are alight in Iraq, as the oil industry has concluded that the Iraqi oil fields will soon fall under American control, and are therefore safe. Prices of other precious commodities, most notably gold, have also fallen, as investors have tentatively started to sell their ‘safe-haven’ assets, and assume more risk by buying back into equities.

However, the currency markets have behaved differently. In volatile trading before the campaign commenced, the euro rose to a four-year high against the dollar, and a three-year high against the pound.

Those sceptical of the single currency’s appreciation dismissed the rally as a symptom of pre-war nerves, and claimed that the dollar and pound would rebound as soon as the campaign began.

Yet we’re now five days into the war, and this hasn’t happened.

Less sceptical analysts, myself included, always questioned this assumption. Undoubtedly, part of the euro’s appreciation was caused by anxious investors abandoning the pound and the dollar, fearing that the UK and the US would initiate non-UN sanctioned war.

However the market was always 100% certain that the Allies would triumph in any conflict, so some of the euro’s rally must have been caused by other factors.

And it was: as it goes to war, the US is massively indebted to the rest of the world.

Conducting unilateral war will worsen this debt by incurring additional costs, and the US will have to borrow in the year ahead to redress its fiscal imbalance.

Borrowing is always an expensive option, especially when lenders know how urgently you need to borrow, and it will restrict economic growth.

Meanwhile Britain is facing a tough budget in April, and it is widely expected that the Chancellor will introduce tax increases to fund existing spending commitments. Increased taxes will dampen consumer spending and ultimately restrict economic growth.

So despite the commencement of war, currency speculators remain uncertain.

The euro’s recent rally wasn’t entirely attributable to the war; investors know that economic fundamentals in both Britain and America point to slower growth ahead, and as a result they are no longer so eager to sell the euro. Investors also know that Eurozone stocks offer better potential returns on investment in the year ahead, given their relative cheaper valuations now, when compared to British or American stocks.

Therefore it’s naïve to expect a mass exodus out of euro denominated assets once the war is over, simply because one element of uncertainty is resolved.

Consequently, if you’re involved in trade outside the Eurozone, start thinking in terms of a stronger euro now, and prepare your business to cope.

After all, in punt terms, we’re only trading at 85p to the pound and $1.35 - hardly levels that would ever have necessitated devaluation in the past.

Niall Dunne, Chief Economist, Ulster Bank Financial Markets