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Euro hit by Irish political chaos, contagion fears

Associated Press
A woman enters a euro discount store in south Dublin, Ireland, Monday, Nov. 22, 2010. Ireland's banks will be pruned down, merged or sold as part of a massive EU-IMF bailout, the government says as a shellshocked nation comes to grips with its failure to protect its financial institutions.   (AP Photo/Peter Morrison)
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A woman enters a euro discount store in south Dublin, Ireland, Monday, Nov. 22, 2010. Ireland's banks will be pruned down, merged or sold as part of a massive EU-IMF bailout, the government says as a shellshocked nation comes to grips with its failure to protect its financial institutions.

The euro slid to a two-month low against the dollar Tuesday as a political crisis in Ireland threatened to derail a massive bailout package and amid fears that other European countries could get hammered by markets.

Heightened geopolitical tensions following North Korea's attack on South Korea also weighed on the 16-nation currency, as investors flocked to the perceived safe haven of the dollar.

By late afternoon London time, the euro was trading 1.8 percent lower on the day at $1.3374, just above its earlier low of $1.3370 — its lowest level since Sept. 24.

That means the euro has fallen over four cents in just over a day, since an early rally to a high of $1.3786 following the Irish government's request for financial help.

The initial hope in the markets after Sunday's bailout request by Ireland was that certainty had replaced prevarication. But the euro soon began to move lower, underlining the lack of euphoria surrounding the second bailout of a eurozone country.

Investors are worried that the activation of the bailout will not be as smooth as hoped, as Ireland's premier Brian Cowen fights for his future. Lawmakers in his own party have mounted a rebellion to try to oust him, an effort that could trigger a snap election and delay a massive EU-IMF bailout of Ireland.

On Monday, Cowen pledged to call elections early next year if an austerity budget is passed. His announcement was triggered by the decision by the Green Party to withdraw its support for the government, even though it pledged to back the 2011 budget, due to be unveiled on Dec. 7.

"Generally speaking bailouts are rarely positive events, even when they go smoothly, hence with the current situation in Ireland appearing to be anything but smooth the euro is left in an increasingly vulnerable position," said Ian Stannard, currency strategist at BNP Paribas. "There is now a question mark over the entire process."

The overarching problem, though, remains the worry that European officials have not done enough to prevent the continent's debt crisis from moving on to another highly indebted country, with Portugal and Spain considered the next dominos most likely to fall after Greece and Ireland. Spain is the big worry for EU policymakers because it accounts for around 10 percent of the eurozone economy, in contrast to Greece, Ireland and Portugal, which account for less than 2 percent each.

"Whether investors will be happy to accept these implicit assurances that the Greek and Irish crises were just isolated incidents rather than the logical outcome of some deeper structural issues remains to be seen," said Simon Derrick, senior currency strategist at Bank of New York Mellon.

Derrick highlighted the fact that the difference between the market interest rates on Spanish and German bonds have begun to widen out over the past few days. If Spain gets the same sort of treatment as Greece and Ireland, then there are real doubts that the eurozone would be able to come to the rescue.

"No surprises then that we believe that the post Ireland bailout euphoria for the euro has already run its course," said Derrick.

In the back of investors' minds is the knowledge that previous attempts to keep on top of Europe's debt crisis did not stop the Irish domino from falling — the bailout of Greece, the EU-wide bank stress tests, which the Irish banks incredibly passed and massive liquidity injections from the European Central Bank were all meant to keep trouble at bay.

"There is a real and building risk that at some point the financial markets lose faith with the eurozone authorities' ability to manage the debt crisis," said Derek Halpenny, European head of global currency research at the Bank of Tokyo-Mitsubishi-UFJ.

News that tensions have risen on the Korean peninsula have further weighed on the euro's value against the dollar, as the U.S. currency gets backed by investors looking somewhere considered to be a safe place to park their cash.

Anxiety levels have been elevated by North Korea's artillery attack against the South Korean island of Yeonpyeongm, not least because North Korea has nuclear weapons.

"When it rains..it pours," said Jennifer Lee, an analyst at BMP Capital Markets.

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