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Foreign Exchange

Euro gains probably overdone; Contagion risk still lingers, CitiFX says

The euro's gains following the approval of Greek budget cuts yesterday (Wednesday) may not be sustainable because economies such as Portugal and Spain will still be at risk of sovereign default contagion, Citigroup says.

CitiFX analyst Steve Englander says the degree to which the euro has swung on the Greek news is surprising, and private sectors in eurozone countries will face "intense pressure'' until sovereign debt problems are resolved, which may take more than two years.

"We are surprised on the EUR, because it seemed very likely even last week that the vote would pass,'' he says. "It looks as if the EUR good news is well priced in.''

The euro climbed for the fourth day today and has advanced about 2% this week. Meanwhile the Euro Stoxx 600 Banks index has risen almost 4 percent since Monday’s close.

European governments and financial institutions are working on a French blueprint for discussions on a rescue plan for Greece to avoid a default. German banks and insurance companies met today to hammer out a solution. German and French financials are the biggest foreign holders of Greek debt, and their participation will be key to achieving an EU target of extending the term of at least €30 billion of Greek debt.

Even if the EU can achieve an agreement to roll over Greek bonds, the outlook for other vulnerable countries in the eurozone remains uncertain, particularly with regard to their own austerity programmes, Englander writes.

"Whether such fiscal and credit market pressure is consistent with the tax revenues that peripheral countries have pencilled into their austerity programmes is an open question,'' he says.

Global risk has been set aside over the past few days as investors focused on Greece, Englander says. The CitiFX emerging-markets economic surprise index continued to fall in June, and is at a two-year low. Concerns for global growth remain in view of the effects of emerging markets’ monetary-tightening policies and the delayed effects of rising commodity prices, he writes.

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