Greek turmoil casts shadow over forex market

London

GREECE'S debt turmoil has found a favourite conduit for spreading contagion: the US$5.3 trillion-a-day foreign-exchange market.

From Sweden to Switzerland, central banks are battling to contain an appreciation of their currencies versus the euro. Greek risks are also infiltrating markets in Eastern Europe after Greece's decisive vote against austerity this week.

Even the Bank of England (BOE), whose economy is showing signs of a gradual recovery, may find itself compelled to delay tightening monetary policy, while Japan has signalled it may boost stimulus if the yen strengthens.

"The likes of the Swedish krona and Swiss franc should be worried about a cheaper euro," said Stuart Bennett, London-based head of Group-of-10 currency strategy at Banco Santander SA, Spain's biggest bank. "If that happens, it hampers their fight against their low inflation. The BOE might not like the idea that sterling gains as a safe haven. It's a European issue, but a global foreign-exchange risk."

The concern for the Swiss National Bank (SNB) and Sweden's Riksbank is that the Greek crisis will weaken the euro. Both are struggling to stoke inflationary pressures, and strengthening currencies make that harder. The BOE, which saw the pound reach a seven-year high against the euro last week, has also expressed concern that the exchange rate with the euro may slow UK economic growth.

As the stand-off between Greece and its creditors intensified, the SNB confirmed in June that the central bank sold francs to limit the currency's advance.

Shortly afterwards, Sweden's central bank unexpectedly lowered its main interest rate deeper into negative territory to limit krona gains as it struggles to avoid deflation adding that "it is difficult to assess the consequences of the situation in Greece".

The turmoil may also hamper BOE moves toward higher rates. Despite signs of an economic recovery taking hold in the UK, the central bank may be reluctant to tighten monetary policy while its largest trading partner, the European Union, grapples with Greece.

Last week, BOE governor Mark Carney said the central bank stood "ready to do whatever is necessary to protect" the British economy and it was in "almost continual contact" with its European colleagues.

The Bank of Japan may increase its currency weakening stimulus to address any surge in the yen triggered by the Greek crisis, though any fallout from Europe will probably be limited, an aide to Prime Minister Shinzo Abe said on Monday.

"We've argued for a while that the global currency wars have reached an acute phase in Europe with central banks fighting imported deflationary forces from the eurozone," said Eimear Daly, a currency strategist at Standard Chartered plc in London. "Peripheral European central banks are certainly on high alert in case of accelerated euro weakness or an adverse financial market shock." BLOOMBERG

Read more on the Greek crisis here