BERLIN -- The euro's nightmare may finally be over, and the
European Central Bank's
first real battle may be just beginning.
After seeing the euro lose nearly 30% of its value against the U.S. dollar since its debut in 1999, the ECB decided it was finally time to intervene directly in the foreign exchange markets this morning to support the besieged currency. In a coordinated effort with the
U.S. Federal Reserve
Bank of Japan
Bank of England
, the ECB said it took the action due to "shared concern about the potential implications of recent movements in the euro exchange rate for the world economy." The euro initially surged 5% to over 90 cents, but was recently off those highs near $0.8837.
The question is whether intervention will become a forced habit in the coming days and weeks. Now that a line has been drawn in the sand around 85 cents, the ECB has opened itself in a dangerous way should the euro simply resume its long plunge next week. This could draw it into skirmishes with currency traders trying to test its mettle. The ECB was formed just two years ago, before the creation of the European Monetary Unit, or euro. Of course, the fact that it is not a combat veteran in the currency trenches could make the ECB especially determined to defend the new euro line.
"It really took everyone by surprise," says one German foreign-exchange trader. "They may have to intervene again to make it stick though."
Indications are that the world's central bankers just might be prepared to do that, however. Support for the currency is important for U.S. markets, and in turn investors, because so many U.S. companies now have global exposure. The euro's slump was one factor behind earnings warnings issued in recent weeks by companies such as
Support for intervening on behalf of the euro increased this week as officials met under the auspices of
International Monetary Fund
Group of Seven
meetings in Prague. Both the fund's chief economist
and managing director
voiced support for intervention. Japanese officials also signaled they would be prepared to be flexible in foreign exchange matters. More important seems to have been a change in sentiment for U.S. officials, however.
Perhaps faced with a growing number of U.S. companies that were being hurt by the euro's pronounced weakness, Treasury officials decided to deviate from their strong-dollar policy. Whether Larry Summers could justify more intervention if it appears not to be working so soon before the presidential election is uncertain.
Without the Americans onboard, continued action would have little chance of success, but the ECB can probably not risk a renewed slide of the euro regardless. The inflationary danger presented by the weak euro could force the ECB to hike interest rates higher, which could then hurt the region's prospects for growth. That in turn could hurt the euro's value.
Many economists have long considered the euro's plunge unjustified in light of Europe's robust economic recovery. "The slide has been overdone, but the market sentiment has just been too negative," says Klaus Baader, economist for
in London. Baader thinks Friday's intervention may give the market a moment to reflect upon Europe's solid fundamentals, giving the euro a chance to gain its footing.
And if the euro begins to slide again? The ECB has "staked a lot of credibility on this," says Lehman's Baader. "If they have to, they'll be back."