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Risk of Sharp Euro Fall Increasing: Citi

Having successfully agreed a package to restructure Greek debt, European policy makers had hoped they would have some time to push on with economic reforms without the threat of imminent financial crisis.

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Unfortunately events have again overtaken them, analysts at CitiFX said.

“The rapid advent of the Spanish crisis, its spread to Italy, new concerns on the Netherlands and very poor economic data have caught them flat-footed and so far there is no indication that any policy response is thought to be needed," said Steven Englander, the global head of FX strategy at CitiFX said in a research note following a volatile session for global assets on Monday.

With conditions turning around so quickly Englander believes the European Central Bank needs to show it takes the deterioration in conditions very seriously.

“If the ECB does not provide relief and especially if they give a complacent signal on market conditions, the euro is likely to break to the downside sharply,” said Englander, who believes the upside risk for the euro is also considerable if the central bank puts together an effective policy response.

With rising 10-year borrowing costs increasing costs for euro zone members - with the exception of Germany - Englander says growth rates, or lack of growth, is becoming a major problem.

The spread between peripheral debt and the German bund is, according to Englander, about a risk premium and not a result of ECB policy. But will have the same result nonetheless, he said.

“One reason that tail risk is euro negative is that it reduces any prospect that the euro zone has of growing out of its debt crisis. Hence, if FX investors perceive that no policy response is forthcoming, the euro is at risk of falling sharply,” said Englander.