European Stress Test – What Next for Euro Rates

28 July, 2011


Markets around Europe are bracing themselves for the release of the ‘stress test’ results at 4pm UK time today – which will be the result of the most comprehensive review of banking and credit in the EU since the global financial crisis in 2008.

Between 10 and 15 European banks are expected to fail the test, and will be given until September to submit plans to plug any gaps in their capital adequacy.

Is this likely to weaken the Euro, improving the best rates for sending Euros abroad from the UK? The answer to this will depend on how bad the results are perceived as being, specially given recent worries over the Italian economy, which have added to the well documented problems in Ireland, Greece and Portugal.

If more than 15 banks fail the test, we could expect some Euro weakness, but on the other hand the transparency of the new tougher tests and the fact that the EBA (European Banking Authority) at least have a strategy to deal with the weaker banks, could be seen by markets as a sign of strength thus making the Euro more expensive.

This also explains recent Euro strength in the face of bond ratings falling across the Eurozone and talk of further bailouts, which has not provided the Euro weakness many of you buying property overseas had been hoping for.

When the dangerous exposure of the UK banking sector to many of the ‘problem’ Eurozone countries is also considered, perhaps it is easy to see why the Pound has been suffering and not making the gains against the Euro that at first sight might have been expected.

So, even if the stress test results this afternoon are worse than expected, it might be unlikely that exchange rates will improve, and whether you are sending a payment to Spain, France or anywhere else it could pay to consider fixing an exchange rate now. The problems in the Eurozone have a track record of producing a stronger (more expensive) Euro, even though that may seem strange at first.

Until we have sight of more interest rate rises in the UK (not expected until November at the earliest), sterling is likely to remain weak, and higher interest rates in the Eurozone will only continue to fuel demand for the single currency, keeping exchange rates low for some time to come.