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A weaker currency will help but cannot rescue the stagnant euro zone
Jan 31st 2015 | BERLIN, MADRID, MILAN AND PARIS
ONLOOKERS could be excused for thinking that Christmas had come again to the
euro zone this month. On January 22nd the European Central Bank (ECB) said it
was ready to buy over 1 trillion ($1.1 trillion) of sovereign and asset-backed
bonds between March 2015 and September 2016. Growth, jobs and an end to the
spectre of deflation were euphorically invoked by politicians, businessmen and
journalists.
The immediate result was to grease the skids under the sliding euro, worth
$1.13 at mid-week. It is now down by 19% against the dollar since May 2014, and
by 10% against its trading partners currencies. Most think it has further to
fall.
This is good news for the euro zone, especially weaker members like France and
Italy where many firms struggled to sell their products when the euro was
higher. My dream is parity of the euro with the dollar, said Matteo Renzi,
Italy s prime minister, at a meeting of the economic great and good at Davos. A
cheaper euro should boost economic activity by making exports more competitive
abroad and domestically produced goods more attractive at home. There are signs
that this is beginning to happen.
Euro-zone goods exports were 2% higher by value in the 11 months to November
2014 than in the same period a year earlier, on preliminary figures, with
growth picking up in the second half of the year (see chart). In the first ten
months they increased by 7%-8% to the euro area s main trading partners
Britain, America and China where currencies have strengthened. Imports from
those countries increased by less or fell.
The weaker euro is only one factor: the pick-up in demand in America and
Britain, along with the fall in oil and commodity prices, are others. But
exchange rates matter. Italy s export-credit agency estimates that a 10%
depreciation in the euro-dollar exchange rate could boost the real value of the
country s exports by up to 1.5% in 2015. Companies should reap the benefit, in
the form of either greater sales volumes or fatter margins. The FTSEurofirst
300 share index hit a seven-year high the morning after the ECB s announcement.
Among the industries likely to benefit are carmakers, chemicals and consumer
goods, and especially companies with costs in euros and sales in
strong-currency, growing markets like America and Britain.
Carlos Ghosn, chief executive of Renault, a French car company, says that the
weaker euro will allow industries with excess capacity in Europe to raise
production without costly investment in new plant. Every 1% drop in the euro
against the dollar should add 0.5% to earnings per share, Sanofi, a French
drugs firm, said in October.
The German Engineering Association believes the euro s dramatic drop against
the Swiss franc (the Swiss Central Bank abandoned the franc s three-year link
to the euro on January 15th) will push more buyers of precision machines and
machine tools their way. Indra, a Spanish technology company with two-thirds of
sales abroad, says the weak euro gives it an edge when competing against
American rivals for dollar-denominated contracts. Accor, Europe s largest hotel
group by beds, reported a healthy increase in occupancy rates in the second
half of 2014. Ski resorts in France and Austria are hoping to draw custom from
pricey Switzerland.
Makers of luxury goods are cheerful too, even though they normally insist that
brand and quality, rather than price, fuel their sales. Ch teau Latour exports
85% of its fine wines outside the euro zone. Jean Garandeau, the company s
commercial director, says that though both its costs and direct sales are in
euros, a cheaper currency may encourage distributors to stock up.
But cheaper euros mean costlier imports. Riccardo Illy, chairman of the
eponymous group that owns coffee, tea, chocolate and wine businesses, says that
although they have increased margins over the past three months by keeping
dollar prices stable as the euro has fallen, the overall effect has been
negative: the group must buy dollars to import coffee, tea and cocoa. For many
companies, though, this effect is mitigated by the lower cost of energy (oil is
priced in dollars) and of energyintensive goods.
Partial pass-through
Though individual companies may gain greatly, the overall impact of the cheaper
euro on the continent s economy is likely to be less dramatic. It is not just
that almost half of euro-zone countries exports of goods go to other members
of the block; those products may still take market share from harder-currency
rivals. But most of Europe s big companies are increasingly far-flung. More
than two-thirds of the workforce of the French firms that make up the CAC 40
share index were based abroad in 2012, according to calculations by Les Echos,
a business daily.
Many firms produce in the countries they sell to, or find other ways to match a
portion of ongoing costs and revenues. Such natural hedges limit the impact
of exchange-rate changes. At Safran, a French aerospace and defence firm, half
of non-euro revenues (which make up 80% of total revenues) are hedged with
non-euro costs. Safran aims to protect the rest of its exposure three years out
using derivatives.
In faster-moving, lower-margin industries such as clothing, firms are less
inclined to pay for that kind of protection: Inditex of Spain is believed to be
one that does not. But only a portion of most big companies operations are
directly sensitive to currency movements. Peter Oppenheimer of Goldman Sachs,
an investment bank, says that nowadays the main impact of foreign-exchange
movements is translational determining the rate at which revenues and profits
abroad are converted into a firm s reporting currency for accounting purposes
and not operational.
In any event, it takes time for currency movements to feed through to the real
economy in the form of bigger market shares, fatter margins, new jobs or new
investment. French firms are among the least profitable in Europe; most may
want to rebuild margins before they set about producing more to sell abroad.
Many German exports are of high-value-added products for which demand reacts
little to price changes: cheapening by 10-20% will not reverse the slowdown in
exports to the pinched Chinese consumer. Spain s sales abroad were already
buoyant because firms had cut costs and prices. The very speed of this currency
realignment may make business executives hesitate to base big investment
decisions on it, says Ross McInnes, Safran s deputy chief executive.
He also points out the danger of mistaking the trees for the wood. What matters
more than currency fluctuations in trade is demand, and world growth is soggy.
A weaker euro will help Europe s firms, but it is only part of a bigger
picture.