Split and slide

It’s euro strength rather than weakness, that is remarkable. But a swift slide in its value is now probable. A possible Greek exit from the zone in the coming months is the big near-term risk. But there is also a broader threat. As the crisis persists, France and Germany are growing further apart. More growth? Less austerity? A zone torn by discordant voices is vulnerable to a split and the euro to a slide.

Euro strength has perplexed. Even after unsettling elections the euro is still well above the $1.17 level at which it launched. The solidity may reflect Germany’s annual trade surplus of around euro 220 billion, the balanced trade position of the zone, and the European Central Bank’s one per cent interest rate — higher than in United States, Japan and UK where outright quantitative easing have provoked currency weakness. But the ground is shifting. While the United States seems to have finished money printing as its economy grows, the euro zone has returned to a recession which is deep in the periphery. And European political uncertainty is worsening.

Greece may end by electing a government that will not stick to the austere terms of the country’s second bail-out. Markets ought perhaps to be ready for a long-foretold Greek euro exit. But if Greece can exit the zone, why not Spain or Portugal?

Contagion risks are heightened by differences at the core. François Hollande, the new French president, is opposed to austerity in France and ill-placed to impose it in the periphery. Hollande’s preference may be for supportive fiscal spending and a far more expansive ECB. Germany won’t agree and the ECB will want its independence respected. Conflicting voices present the periphery with a temptation: why not call for monetary and fiscal rescue rather than implement tough reforms?

The uncertainty is weighing on global markets. Amid a general lurch away from risk assets, the euro seems likely to make a sharp downward run towards $1.20. Against the pound, the euro has already dropped to its lowest since 2008. A fall towards 75 pence in coming months is now possible. And the euro will probably sink back soon to its sub-¥100 lows of a few months ago. A schizophrenic zone still has a remarkably strong currency. Not for much longer, perhaps.