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Euro Viability Questioned as Germany's Uncompromising Stance on Greek Debt Signals Major Fault-Lines Remain

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Hans Redeker at Morgan Stanley

Above: Hans Redeker, Morgan Stanley (C) Pound Sterling Live.

The European union is shifting further away from integration not closer, and this is not good news for the Euro's long-term outlook.

For Hans Redeker, head of global FX strategy at Morgan Stanley, it's not Italy's new Euro-sceptic government, or where Eurozone PMI's are headed, that is of most concern regarding the Euro's outlook.

Rather, it was at the IMF meeting in April where the Troika reunited to discuss how to help Greece, whose bailout programme was fast expiring, that has given reason for concern. The event reminds the analyst of the potential for ongoing instability in the Euro owing to the Eurozone's construct.

It was at this meeting that the new German Finance Minister Olaf Scholz would debut, after taking over from Wolfgang Schäuble, his famously hardline predecessor - the question was would he remain equally unsympathetic to Greece's debt woes or would he cut the country some slack?

In the end, Scholz decided to hold Schäuble's hard line, insisting Greece would have to show more stomach for reform if it wanted relief, and it was then that Redeker decided the outlook for the Euro had materially worsened.

"The market had been anticipating that the German position would soften and apparently at the IMF it became clear that it would not soften. So we did immediately see that after the IMF the Euro started sliding - before the meeting it was at 1.23 and a week later it was already at 1.21," says Redeker in an interview with Bloomberg.

It is not just one meeting, either, according to German daily Handelsblatt, Sholz has kept most of his predecessor's core team on board and has elected the former head of Goldman Sachs Germany as his chief advisor.

Without more willingness from core countries like Germany to integrate, however, which would essentially involve absorbing the debt problems of their less fortunate brethren, the Euro's days are numbered.

Redeker observes that there is no precedent for a currency union without a political union except in Germany in 1834 when a currency union (the birth of the Mark) briefly preceded full-blown integration. However, he does not see a currency union on its own as sustainable.

"A currency union does need to develop a political union, you cannot have a currency union without a political union," says Redeker.

Yet, if anything, recent events seem to indicate even less desire - even from the core - to embrace the periphery, which is, according to Redeker, more at risk from the rise of populism and nationalism than the centre, because of the social and economic fallout from the financial crisis and years of austerity, "rising unemployment and inequality".

However, the Euro may not fall immediately, or predominantly versus the US Dollar, says Redeker who thinks that the US Dollar is "peaking" within a secular bear market, which suggests short pressure on EUR/USD could ease up.

Morgan Stanley has not updated its bearish forecast for EUR/USD to reach 1.1500, which it has now already achieved.

Meanwhile, Charlie Jamieson, Bond analyst at Coutts private bank, sees the potential for the pair to fall to 1.12.

Jamieson says the combination of worsening data, sluggish inflation and Italian political woes are likely to prevent the European Central Bank (ECB) from having sufficient confidence to take the patient off its quantitative easing life-support stimulus programme and then begin raising interest rates, and since rising interest rates are a major driver of currency appreciation - because they attract more inflows from investors seeking higher returns - the delay will hurt the Euro.

Morgan Stanley's Redeker says politics more than data will be the prime driver for the single currency in the near future, so Euro traders should keep an eye on the news flow out of Italy to anticipate the single currency's next moves.

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