July 22, 2020 / 3:16 PM / 24 days ago

Breakingviews - Euro moves a step closer to becoming a safe haven

Euro coins are seen in front of displayed flag and map of European Union in this picture illustration taken in Zenica, May 28 2015.

LONDON (Reuters Breakingviews) - The European Union has shoved the euro a step closer to being a safe haven. The 750 billion euro fund that EU leaders agreed earlier this week will make the bloc more stable and issuing jointly backed bonds will boost the single currency’s appeal in times of stress. But there’s a lot more to do.

In theory, the euro is an ideal safe haven. The combined debt of the EU’s 27 members was worth 78% of GDP before the pandemic, lower than the United States or Japan. The region runs a current account surplus, making it less dependent on flighty foreign lenders. And nearly a third of global payments involve the euro.

Yet political realities are a hindrance. Weaker states – including the region’s third biggest economy, Italy – are vulnerable to downturns, which keeps breakup concerns alive in the background. And the bloc lacks a common safe asset. Germany’s determination to cut debt has limited the supply of its bonds, viewed as the safest in the region. As a result, the euro accounts for a fifth of world currency reserves, compared with the dollar’s 62%, according to the International Monetary Fund.

The EU recovery fund helps. Stronger countries will cushion the economic pain felt by weaker peers, reducing the risk of a country quitting the euro zone. And the fund will be financed by jointly backed bonds, which will be a vast pool of low-risk debt. Optimism after the EU deal was struck drove the euro on Wednesday to $1.16, its highest level against the dollar in nearly two years. Mizuho analysts reckon it could reach $1.30 if the single currency starts to acquire a safe-haven premium.

Yet it’s still not clear if the fund is the template for more integration or an exception. It took a global pandemic for EU leaders to agree to something that is worth less than 6% of the bloc’s 2019 GDP. Less drastic shocks may not elicit such solidarity. And anti-EU sentiment could rise when citizens in so-called frugal states realise the financial commitments their leaders have made. It may take more crises to force the EU to make progress, and for the euro to truly earn a safe-haven status.

Breakingviews

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