Euro Weakness Is ‘Desirable’ to Counter Deflation, Resona Says

May 18 (Bloomberg) -- The euro may extend its slump below a four-year low against the dollar as the European Central Bank tolerates the currency’s decline as a way to counter deflation, according to Resona Bank Ltd.

While the emergency funding package announced by European leaders last week has reduced the risk of contagion, the region’s economy will struggle as nations such as Greece and Portugal cut spending to tackle their budget deficits, said Koichi Kurose, chief strategist at the unit of Japan’s fourth- largest banking group in Tokyo.

“Given the likelihood that austerity measures will pose downside risks to the region and enhance deflationary pressures, a weak euro is probably desirable for the economy and for the sake of the market’s stability,” Kurose said in an interview. “The euro is most likely to underperform against the U.S and Japanese currencies.”

European Union policy makers last week unveiled an unprecedented loan package worth 750 billion euro ($928 billion) and a program of bond purchases to combat the region’s spreading sovereign-debt crisis.

The euro briefly rallied after the announcement before resuming its decline. The 16-nation currency fell as low as $1.2235 yesterday, the weakest level since April 2006 before trading at $1.2349 as of 10:38 a.m. in Tokyo.

Spain’s underlying inflation turned negative last month for the first time. Consumer prices excluding energy and fresh food fell 0.1 percent from a year earlier, the National Statistics Institute said May 14.

‘Not Worrying’

Belgian Finance Minister Didier Reynders said yesterday the decline in the euro was “not worrying” and Luxembourg Prime Minister Jean-Claude Juncker, who leads the group of euro-area finance ministers, said the euro is a credible currency.

“Unless the decline in the euro starts to spiral out of control and as long as the ECB views its decline as being orderly, the central bank won’t try to intervene regardless of the currency’s levels,” Kurose said.

Although the ECB said yesterday it will reduce the size of its balance sheet, Kurose said if the central bank outlines an intention to loosen its monetary policy this may quicken the euro’s decline.

The ECB said it will invite banks to deposit cash with it for one week to prevent its purchases of government bonds from increasing the money supply. The central bank said it will take term deposits for the first time to mop up 16.5 billion euros of bond purchases settled up to May 14.

The slide in the stocks over the past week may represent a buying opportunity for investors, Kurose said.

“Unless fiscal consolidation measures in Greece falter completely, the risk of a break-up of the euro is comparatively small and Greece is not likely to leave the single currency bloc,” Kurose said. “The debt problems in Euro won’t threaten the global credit system and endanger the prosperity of the world economy, which holds the key to the stock market.”