By Bo Nielsen and Kim-Mai Cutler Oct. 14 (Bloomberg) -- The European Union's 1.1 trillion euro ($1.5 trillion) plan to bail out the region's banks may have come too late to keep the euro's biggest drop on record from getting worse. While leaders of the 27-nation EU agreed in the past two days to guarantee bank loans and take stakes in lenders, currency strategists and investors say the actions may not prevent the region's economy from slowing. Morgan Stanley predicts a decline in the euro to $1.25 by 2009, from $1.3670 today and $1.60 in July, and strategists at BNP Paribas see weakness after ``some support in the near term.'' ``The euro was overbought, over-owned, over-rated and overvalued,'' said Stephen Jen, the global head of currency research at Morgan Stanley in London. Jen correctly predicted in July that the euro would slump just as it began to weaken 15 percent. ``The strategic view has to be that a global recession will keep seeing the euro sold off.'' As recently as April, economists at the National Bureau of Economic Research in Cambridge, Massachusetts, predicted the euro would overtake the dollar as the world's reserve currency. The outlook isn't so bright now because the region's economy is forecast to slow more than the U.S. and Europe's interest rates have further to fall. EU government leaders failed before the weekend to agree on a plan to rescue financial institutions from the seizure in credit markets that caused the Dow Jones Europe Stoxx Banks Index to tumble 55 percent between the start of September and Oct. 10. The Oct. 12 pact came more than a week after the U.S. set its own rescue plan in motion. `Concrete Measures' ``We need concrete measures, we need unity, which is what we achieved,'' French President Nicolas Sarkozy said at a press conference on Oct. 12 at the Elysee Palace in Paris. ``None of our countries acting alone could end this crisis.'' European leaders agreed to back new bank debt and use taxpayer money to keep distressed lenders afloat, trying to stop the worst rout in Europe's stock markets in two decades and stave off a recession. Germany will provide 500 billion euros in loan guarantees and capital, equivalent to 20 percent of its economy, while France set aside 320 billion euros of loan guarantees and 40 billion euros to buy stakes in beleaguered banks. Spain's cabinet approved measures yesterday to guarantee as much as 100 billion euros of bank debt this year and authorized the government to buy shares in banks in need of capital. `Waiting for Details' ``We got a unified announcement, but we're still waiting for details,'' said Simon Derrick, chief currency strategist in London at Bank of New York Mellon Corp., which holds $23 trillion as the world's largest custodian of financial assets. ``The lack of clarity, relative to that of a single government, is quite telling at a time when investors crave clarity.'' The euro may drop below $1.20 in a year, he said. The euro rose 0.6 percent today following a 1.3 percent rally yesterday, to $1.3670, and gained 1.1 percent to 139.63 yen. The currency closed last week at $1.3408, the lowest since June 2007, and fell to 134.96 yen, down from an all-time high of 169.96 on July 23. The euro's 7 percent drop against the yen last week was its biggest decline since the currency was created in 1999. Strategists and investors say the gains may not last. The economy of the euro region will expand 1.35 percent this year, slowing to 1 percent in 2009, according to the median of 32 forecasts compiled by Bloomberg. Growth in the U.S. will be 1.6 percent this year and 1.2 percent in 2009, a separate survey of 75 economists showed. Rate Liability Higher interest rates, which supported the euro in the first half of the year, are becoming a liability as the global economy slows. The European Central Bank joined the Federal Reserve and four other central banks in cutting rates last week by half a percentage point, lowering its target to 3.75 percent from 4.25 percent. The Fed cut its key rate to 1.5 percent from 2 percent. The Bank of Japan held at 0.5 percent. The ECB, based in Frankfurt, will reduce the rate to 3.5 percent next year, according to the median estimate of economists surveyed by Bloomberg. Goldman Sachs Group Inc. in New York predicts a decline to 3 percent. ``The surprisingly unified approach to emerge from Europe over the weekend will also likely see the euro regaining some support in the near term,'' Sebastien Galy, head of foreign- exchange research at BNP Paribas in New York, wrote in a report to clients yesterday. Even so, ``we continue to expect the dollar to move higher,'' he said. Overtaking the Dollar When the euro was rallying 38 percent from November 2005 through July, economists said the dollar was in danger of losing its place as the leading reserve currency. The euro's share of global central bank reserves increased to 27 percent at the end of March from 17 percent in 2000, as the dollar's share fell to 62.5 percent from 72.1 percent, according to the International Monetary Fund in Washington. The National Bureau of Economic Research, the group that determines when recessions begin and end, said the euro may become the world's leading reserve currency in the next seven years. Jeffrey Garten, a professor of international trade at the Yale School of Management in New Haven, Connecticut, and undersecretary for commerce and international trade in the Clinton administration, said in November the world was undergoing a ``rebalancing'' of economic power. Supplanting the dollar is looking increasingly unlikely as the credit crisis threatens to tip the global economy into a recession. Global Slowdown The IMF's World Economic Outlook last week forecast that global growth will slow to 3 percent in 2009, from 3.9 percent this year and 5 percent in 2007. That would mean a world recession under the fund's informal definition. ``In a global recession the dollar will do well as we'll see further repatriation,'' said Momtchil Pojarliev, head of currencies at London-based Hermes Pension Management Ltd., which has about $70 billion under management. ``This just highlights that the dollar remains the world's reserve currency.'' The euro will fall to $1.20 by the end of next year, Pojarliev forecast. Hermes is betting the euro will decline versus a basket of currencies including the U.K. pound, Swiss franc, Swedish krona and dollar, he said. ``The ECB will basically cut rates while the Fed is almost done,'' Pojarliev said. ``That will move the balance in favor of the dollar.'' Currency Forecasts Frankfurt-based Deutsche Bank AG, the world's biggest currency trader according to a Euromoney Institutional Investor Plc survey, says the euro will depreciate to 134.41 yen and trade at $1.38 in 12 months. David Simmonds, head of currency research in London at the Royal Bank of Scotland Group Plc, wrote in an investor report last week that it may drop to $1.25 by the end of next year. The median estimate of 38 strategists surveyed by Bloomberg that gives greater weight to most recent forecasts is for the euro to trade at $1.36 in mid-2009. In August, the expectation was $1.45. Against the yen, it will likely trade at 146, compared with an August prediction of 158.50. While European leaders agreed on a program to combat the growing credit crisis spreading through the region, they must now convince their individual governments that the plans make sense. The stakes are rising after the IMF said on Oct. 7 that the world's major banks may need $675 billion in fresh capital over the next several years. Financial institutions have lost or written down $635 billion since the start of last year amid the worst housing slump since the Great Depression, according to data compiled by Bloomberg. The ``euro is an emperor without clothes,'' a team led by Tom Fitzpatrick, global currency head of strategy at Citigroup Global Markets in New York, wrote in a report Oct. 8. ``A single currency without a coordinated system behind it. The European financial system is being stress tested.'' To contact the reporters on this story: Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net; Kim-Mai Cutler in London at kcutler@bloomberg.net

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