It now seems the euro's strength of the past three years is coming to an end, much to the relief of European exporters.

Predictions of the euro reaching US$1.40 anytime soon can be tucked into the filing cabinet under the desk.

Instead, the currency, shared by 12 European Union nations, is heading back towards parity with the greenback.

"The rise of the US dollar against the euro will continue this year, and beyond," says Dirk Chlench, an economist with Hypothekenbank in Essen AG, in an e-mailed response to questions.

He pointed to the recent drop in overseas purchases of US assets as illustrative of the changed mood. "A few weeks ago, such economic news might have triggered a US dollar sell-off."

It may be only a blip. Still, since mid-March, the currency has slumped from US$1.34 to its current level of US$1.25.

"I suspect we are now witnessing the beginning of a bearish trend for the euro," Joachim Fels, chief global fixed-income economist at Morgan Stanley in London, wrote in a recent note to investors.

"To put a number on my view, I think parity could be broken within the next 18 months," he says.

There are certainly plenty of reasons to sell the euro.

Growth in the euro area remains weak, and Italy has just slipped back into its second recession in two years.

The watering down of the stability pact, which limits budget deficits to 3 per cent of gross domestic product, will lead to more widespread government borrowing across the region.

EU constitution

And the likely rejection of the EU constitution by one or more countries will only weaken the political consensus around integration.

Meanwhile, the governments in Germany and Italy will probably be kicked out of power in the next two years.

Nervous politicians will start pandering to their electorates with protectionist and anti-business rhetoric in Germany, that has already started.

On the other hand, there are plenty of reasons to buy the dollar.

US growth outlook for 2005 is stronger than Europe's a Bloomberg survey of 63 economists in May revealed an average forecast of 3.4 per cent for the United States. The European Central Bank (ECB) expects growth of about 1.6 per cent for the euro area.

And US interest rates are rising the federal funds rate is currently 3 per cent helping lure investors back to the dollar.

Even the "twin deficits" seem to be improving.

The US Government posted the largest April budget surplus in three years, and the trade deficit in March shrank to US$55 billion, the narrowest in six months.

Relief for exporters

The period of euro strength hasn't been wasted.

It has forced many European companies to get leaner, and to trim costs.

Munich-based Siemens AG, one of Europe's largest manufacturers, has been pushing through more flexible working hours at its German factories, in return for preserving jobs in its home market.

As the euro continues its decline, expect exporters to report higher sales and bigger profits.

Companies such as Finland's Nokia Oyj, the world's largest cellphone maker, and France's LVMH Moet Hennessy Louis Vuitton SA, the biggest manufacturer of luxury goods, have said the strong euro has been hurting earnings and sales.

Soon, they will be able to reverse that trend.

Next, the ECB has been fretting for some time that interest rates at 2 per cent are abnormally low.

Yet, it has been constrained by fear an increase would push the euro higher, damaging already weak economies.

The brake on interest rates has now been released.

The result? In the next six months, don't be surprised if the ECB increases borrowing costs.

For the past three years, there has been only one bet in the currency markets: The dollar would keep falling.

That has changed and Europe's companies will benefit.

Bloomberg News

(China Daily 05/30/2005 page11)