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Euro will survive, but only with ECB intervention

Tuesday 22nd November 2011

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The European common currency, the euro, will survive its current crisis, but it will require direct intervention by the European Central Bank to solve, says the chief investment strategist in Asia-Pacific for Russell Investments, Andrew Pease.

At a breakfast presentation in Wellington, Sydney-based Pease told New Zealand fund managers the Eurozone was impossible to pull apart, because “it was designed not to be unscrambled”, although it could fail if the ECB failed to use the powers expected of a central bank to act as lender of last resort.

“It’s like watching a slow motion car crash,” said Pease, who was critical of the new Governor of the ECB, Mario Draghi, for continuing to hold the line emanating from Germany that European states need to put their own houses in order rather than expect a bail-out created by the ECB printing money.

While the ECB had been buying European sovereign bonds “surreptitiously” in recent weeks, half-hearted interventions would fail, whereas “a determined central bank would set a floor.”

“They would have to cut interest rates and engage in quantitative easing (printing money), which all seems a long way off,” Pease said.

“I expect the Euro to be here in a year’s time, but it will be a bumpy ride in the next couple of months”, with the likelihood of more European bank collapses in the meantime. Nor could he be as confident today as six months ago that all 17 countries using the Euro would remain in the common currency, despite the heavy price any departure would impose on the departing country and to banks exposed to its debts.

“There’s a game of brinksmanship going on. There’s a whole lot of things the ECB could do, but things in Europe will have to get a whole lot worse before they start getting better.”

Elsewhere in the global economy, Pease said equities were looking on average under-valued, that pessimism about the American economy is “overdone” and that early signs of a resumption of US housing starts are evident, albeit a very large number of foreclosed properties have still to come to market.

His prognosis for China is that although a European slowdown would hurt its growth, there would be no ”hard landing”, and that any softening in China would be positive for Australia, whose exchange rate was currently “seriously over-valued” against the US dollar.

“The US dollar looks cheap and I’m picking it will win the ‘least ugly’ competition” among major exchange rates, said Pease, especially as it was vital for European recovery that the strong Euro become weaker.

With equities undervalued and interest rates on sovereign bonds at historic lows, Pease also predicts a switch from bonds into equities in coming months.

“At some stage, this will be the one to watch,” said Pease. “The most conservative part of the portfolio (bonds) looks expensive compared to the riskiest part of the portfolio (equities).”

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