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Brussels faces a steep climb in its effort to boost the international role of the euro as part of its quest to strengthen the EU’s self-reliance, investors and analysts said after the bloc set out new ambitions for the single currency.
A European Commission paper on Tuesday argued that the EU’s unprecedented €750bn borrowing programme, which will pay for its Covid-19 recovery fund, will add “significant depth and liquidity to the EU’s capital markets”, making them and the euro more attractive for investors.
“For the foreseeable future the EU will be a substantial player in the international markets, and it is clear that this will help us strengthen the international role of the euro,” said Valdis Dombrovskis, commission executive vice-president, as he helped launch the new paper.
But Myles Bradshaw, head of global aggregate fixed income at JPMorgan Asset Management, said he was sceptical that the recovery fund — which is by its nature designed to be temporary — would by itself be a game-changer for the euro’s role.
“Part of the characteristics of an international currency is a deep liquid bond market that’s easy to invest in. Having a bigger pool of assets is helpful. But there’s so much else that goes with it — and that’s where the euro gets left behind,” Mr Bradshaw said.
The EU has long wanted to challenge the US dollar’s dominance in cross-border finance and trade, but there has been little progress on this in a range of areas.
The euro’s share of global foreign exchange reserves has fallen from 23 per cent a decade ago to 20 per cent in 2019, while its use in invoicing for eurozone exports and imports has remained steady at around 60 per cent and 50 per cent, respectively.
One of the few areas where it has established a dominant position is the fast-growing green bond market, almost half of which is denominated in euros.
Maria Demertzis, deputy director at the Bruegel think-tank, said that the size of the fresh issuance of euro-denominated safe assets was not by itself enough for the euro to be a “contender” with the dollar. The bloc also had to tackle residual investor doubts arising from the single currency’s “imperfect architecture”, which is based on a union of multiple sovereign states not just one.
The eurozone’s capital markets remain less developed and more fragmented than those of the US, something the commission is seeking to address via its long-running capital markets union plan. Key elements of monetary union remain uncompleted, including the banking union project, which ministers are also seeking to accelerate.
Ms Demertzis encouraged the EU to focus on getting more transactions in euros instead of dollars, for example in energy invoicing. This is something the commission report highlights as an area of recent progress, as it vows to foster the euro’s status as an international reference currency in the energy and commodities sectors.
Despite scepticism about the euro’s ability to rival the dollar, some EU officials insist the scale of its new borrowing programme has the potential to be a game-changer, alongside other steps to boost the currency’s attractiveness.
Last year’s deal between member states on the recovery fund “is seen in the markets as a potential shift in European integration, not just a one-off event”, said one EU official. “There is an appetite among public and private institutions for something that helps them diversify away from the dollar, and they see Europe eventually having the critical mass for that.”
Kalin Anev Janse, chief financial officer at the European Stability Mechanism — the eurozone’s bailout fund — said the agreement on the recovery fund had sparked greater interest in euro assets among foreign reserve managers.
Central banks from outside the eurozone have been buying a larger share of ESM debt sold since the summer, according to Mr Anev Janse. “Ten years ago markets were betting on a break-up of the single currency, but today is a completely different crisis, ” he said. “The monetary and fiscal response has been faster this time. Investors have gained confidence that Europe will stick together.”
Common European debt from the commission and European Stability Mechanism represents €450bn today, but this will leap to €1.23tn in five years, driven in large part by recovery fund borrowing, according to ING projections. Factoring in borrowings from the European Investment Bank, the total will reach €1.75tn, according to ING analyst Benjamin Schroeder.
That figure would put the EU and these agencies among the region’s top debt issuers: Italy currently has €2.15tn of bonds, with France at €2tn and Germany at €1.46tn.
The commission paper was first reported by the Financial Times on Saturday. It also touts the potential introduction of a digital euro by the European Central Bank as a potential boost for the single currency.
Fabio Panetta, an executive board member at the ECB, said in a recent speech that a digital euro could become “an attractive payment vehicle or store of value for non-euro area residents” and therefore boost the currency’s international usage.
It could also weaken the US dollar’s role as the clearing currency for most international payments if other central banks agreed to process cross-border payments directly by swapping digital currencies, an idea outlined in a recent ECB report.
