RPT-ROI-Europe’s euro worry a mirror of US dollar dilemma?: Mike Dolan

By Mike Dolan

LONDON, Jan 29 (Reuters) - Europe wants to embrace a beefed-up role for the euro in world finance but gets anxious when that success pushes the currency higher. If the dollar is indeed shaping up for another protracted slide, the bloc faces the flipside of a dilemma Washington is trying to shake off.

As the dollar =USD swooned around the world this week, the pivotal transatlantic exchange rate briefly soared above $1.20 per euro for the first time in four years. The move rang alarm bells again at the European Central Bank and in European industry, but it also flattered euro-based investment portfolios and potentially drew in much-needed foreign and domestic capital.

While much attention has been on the dollar's latest quake, euro EUR= strength has been building more broadly since Donald Trump's return to the White House a year ago. The ECB's broad trade-weighted euro index has now climbed more than 7% in that time to record highs, thanks mainly to the 16% rise against the dollar but also more than 10% gains versus China's yuan CNY= and Japan's yen JPY=.

The tensions surrounding all that are clear.

Within hours of the euro surge through $1.20 on Tuesday, ECB officials - who had been signaling for months that they were happy with the current broadly neutral level of interest rates - started to mutter once more about needing to counter any "excessive" euro strength.

Their worry is that an outsize euro surge from here would both hit Europe's industrial exporters and risk a significant undershoot of the ECB's 2% inflation target, which is now being met. A resumption of interest-rate easing, or the threat of it, would be the central bank's first weapon of choice.

Austria's central bank boss Martin Kocher talked of responding if the euro rose "further and further" and Bank of France chief François Villeroy de Galhau said the ECB was "closely monitoring the appreciation of the euro."

The nods and winks were enough for euro money markets to briefly price in a 25% chance of another ECB cut by midyear - which pulled euro/dollar back below $1.20.

There is an upside to all this, though, not least if the exchange-rate move both reflects and encourages some reversal of the overwhelming bias toward U.S. investments of the past decade - a bias most obvious among euro zone investors themselves.

And if easier ECB credit comes from euro strength, it cossets hefty European government borrowing. Cheaper dollar-priced energy softens the business blow.

But crucially Europe's economies need trillions of euros to fund defense, innovative tech and green-energy refits. That challenge is sharper now that the region is being pushed toward "strategic autonomy" in trade, business and military policies as Washington seeks to upend the standing world order.

That need is partly the reason ECB President Christine Lagarde has pushed the euro's role as a reserve asset over the past year of turbulence, advocating a "global euro". As it stands, the euro is still a distant second to the dollar in world central bank reserve holdings or external usage.

Getting that without the exchange-rate pain isn't easy.

And in this respect, Europe's potential conundrum is the mirror image of Washington's. The Trump administration seems happy to unwind years of dollar appreciation as part of a global trade reset and a reindustrialization push.

However, years of dollar gains were both a result of and a driver of exceptional U.S. economic and asset-market performances. Deflating just the currency part for trade gains will be hard without pulling the rug from the whole edifice - and potentially denting the dollar's dominant role in the process.

As Citi strategists pointed out on Wednesday, pursuing a weak dollar could hurt foreign Treasury demand - especially in short-end debt, where there's less hedging but where Treasury is loading an increasing amount of its new debt.

"Rapid depreciation could also lead to higher inflation," they added, a headache for both the Fed and the administration.

Societe Generale echoed that view, arguing that the most fragile part of U.S. exposure to overseas investors lies in debt, not equities. Last year's trade jolt and dollar swoon coincided with a drop in America's share of global non-resident debt investment, even as its share of foreign equity flows rose further.

No doubt aware of these risks, and after Trump called the currency moves "great" on Tuesday evening, Treasury Secretary Scott Bessent attempted to steady the ship on Wednesday by restating, "We have a strong dollar policy."

But as Bessent and others have pointed out many times in the past, a "strong" dollar in the broadest sense is its reserve status and wide usage, and not necessarily its value on the currency markets. Bessent argues that good economic policies would naturally lead to a stronger dollar, but clearly he's the judge of "good" policies in the marketplace.

However, Washington's dance around exchange rate semantics is not that different from Europe's problem. How do you embrace a "global euro" while dodging the exchange rate appreciation that goes with its success?

The opinions expressed here are those of the author, a columnist for Reuters.

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