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Foreign Exchange

Greek debt accord won't halt euro slide, Royal Bank of Scotland says

Investors should take advantage of a rebound in the euro and sell the currency for dollars even if the immediate danger of a Greek default is averted, says Royal Bank of Scotland.

Robert Sinche, RBS's Global Head of FX strategy, says that in addition to ongoing funding challenges for Greece, stronger economic growth in the U.S. during the second half of the year will also pressure the euro as the Fed hikes rates. The likelihood of an ECB rate beyond July looks increasingly unlikely as expectations for inflation and economic momentum decline, he says in a report.

“Our expectation for a EUR/USD decline toward 1.3000 by year-end relies on divergent developments in relative growth and interest movements between the US and Euro zone,'' Sinche says. RBS also “remains concerned about the ability of Greece to meet ambitious targets'' and reviews by the IMF and EU later this year “will pose another challenge for the Greek adjustment process,'' he says.

Expectations for economic conditions in the Eurozone are sliding even though current data such as German business confidence last week showed a rising trend. Softer growth and a lower inflation profile, helped by lower food and oil prices, suggest limited tightening by the ECB, Sinche says.

European finance ministers meet on July 3 in Brussels to discuss a plan for Greece that is supposed to be approved at a second meeting on July 11. Both a Greek vote and an accord with creditors on rollovers are needed to get the new aid package passed. Reviews of Greek progress on privatization and budget cuts by the IMF and EU between September and December will pose more challenges for the government going forward.

There are also market questions about how the ratings agencies take a reprofiling of Greek debt, and whether that prompts rating cuts elsewhere, such as Portugal where a reduction would give its debt junk status, Deutsche Bank says in a report.

Fitch will “very likely'' consider Greece in default should the EU go ahead with the plan to get investors to roll over their Greek bonds, David Riley, head of sovereign ratings in London, wrote in a letter in the Financial Times yesterday.

The euro may also be pressured by concern over bank stress tests, particularly with regard to Spanish banks, with a focus on the need for capital injections that are large enough to be credible but not too large to overly weigh on sovereign accounts, Deutsche Bank says.

The euro “does not belong above this year's 1.4949'' even if the European plan for Greece works, it says. “The market is more inclined to run with a broader long risk trade than a long EUR trade.''

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