European Slowdown

Let me apologize for my hiatus last week; it was the result of a nasty virus that took me pretty much the entire week to recover from. At any rate, I find that my mood is not being improved by reading about the economic situation in Europe. And apparently I’m not alone in my disappointment. Yesterday the Swedish central bank acknowledged the increasingly gloomy economic prospects in Europe for this year when it somewhat dramatically cut interest rates:

Sweden’s central bank cut interest rates by a surprisingly large 50 basis points to a new historic low of 1.50 percent on Tuesday and some analysts said the door was open to further easing.

The decision sent ripples through Swedish markets and beyond, into the euro zone government bond market, where traders said the Riksbank had turned the spotlight on Europe’s economic woes and added to pressure on the European Central Bank to cut rates. Like the ECB, the Swedish central has been under pressure to cut rates to boost sluggish job market with inflation running low.

That pressure on the ECB to cut euro-area interest rates does indeed seem to be growing with each passing week. In response, the dollar has gained surprising strength against the euro in recent weeks, with some observers considering that an exchange rate of $1.10 to one euro is not out of the question in the near future:

The euro continued to fall in European morning trade on Tuesday amid mounting speculation that the European Central Bank may be preparing the market for an interest rate cut.

A newswire report on Monday, quoting unnamed ECB sources, claimed that the Frankfurt-based bank was starting to consider the prospect of a rate cut, having held rates at 2 per cent for the past two years… [A]s Paul Chertkow, head of global currency research at Bank of Tokyo-Mitsubishi, pointed out: “Whatever the ultimate monetary disposition of the ECB, interest rate differentials between the United States and the eurozone are likely to widen further as the Federal Open Market Committee continues to move towards a neutral monetary stance.”

I’ve generally thought that the dollar-euro exchange rate is largely irrelevant to determining the US current account deficit (which is determined principally by national savings balances in my opinion), so I don’t think this changes the US’s trade picture much. But at the very least, if this recent rise in the dollar continues, this certainly does raise the possibility that dollar bears (like Warren Buffett) could be in for some nasty balance sheet surprises in the next few months…