Just two months ago, the euro was widely felt to have better prospects than the beleaguered dollar. But all that has changed thanks to the Greek debt crisis.

Given the events of the past few weeks, the question is how much more punishment the euro can take.

Since concerns began to heighten over the ability of Greece to service its debt at the turn of the year, the single currency has been under relentless selling pressure.

“The question is not whether to sell the euro or not,” says Hans Redeker at BNP Paribas. “The question is when and at what level to sell the euro.”

This year the single currency has lost more than 5 per cent of its value against the dollar. On Friday it dropped to a eight-month low of $1.3529. It has fallen nearly 8 per cent against the yen and has lost ground against the pound, dropping 2 per cent since the start of January.

Greece is a relatively minor eurozone economy, representing about 3 per cent of the region’s gross domestic product. Its problems have hurt the euro partly because of fears over contagion – because other eurozone countries such as Spain and Portugal also have large budget deficits and high labour costs.

But the main driving force of the euro’s fall from grace has been increased focus on a flaw that many commentators believe to be at the very heart of European monetary union.

“Behind this intense focus on Greece is the long-standing unresolved issue of how to enforce fiscal discipline in a currency union of sovereign states,” says Thomas Stolper, at Goldman Sachs.

At stake is the confidence that has turned the euro into the world’s second most widely held reserve currency behind the dollar.

Jens Nordvig at Nomura says the euro has been trading like an emerging market currency over the past couple of months as it has tracked the sell-off in Greek government bond prices.

Michael Hart, at Citigroup, says the euro’s travails are of the EU’s own making. He says that had the Stability and Growth Pact, which requires eurozone members to keep their budget deficits below 3 per cent, not been successively diluted over the past decade, the institutional framework for fiscal adjustment may now have more credibility.

“The eurozone faces its first existential crisis since the euro was launched in 2002,” says Mr Hart. “This seemingly vindicates the sceptics who have long regarded the eurozone as unsuitable for a single monetary policy given the divergence of its member states.”

Mr Hart, along with the majority of analysts expects further losses for the euro against the dollar, with a short-term target of $1.30.

For confidence to be regained, investors have to believe that Greece, and other peripheral eurozone countries, will be able to cut their deficits and lower their debts.

This is perhaps why, so far, EU pledges to support Greece have been short on specific promises: more detail would raise the old issue of moral hazard in that Greece might feel it had less incentive to pursue painful reforms.

Simon Derrick, at Bank of New York Mellon, says any bail-out would put at risk one of the mainstays of euro strength and its status as a reserve currency: the credibility of German monetary and fiscal policy.

He says that should Germany, as many people believe it will, bow to pressure to lead a bail-out, it would be the first time in modern market history that the country had failed to stick to its hard line on monetary and fiscal responsibility.

“If Germany is to effectively provide a guarantee to underpin Greece, the long-term trend in the euro will be resolutely lower,” says Mr Derrick.

Also weighing on the euro has been a deterioration in economic data, which are likely to delay any move to lift European interest rates. Data on Friday showed the eurozone economy grew at just 0.1 per cent in the fourth quarter, well below forecasts.

One factor that might reverse the euro’s fortunes is the fact that investors are already positioned for more euro losses.

Figures from the Chicago Mercantile Exchange, often used as a proxy of hedge fund activity, showed investors increased their bets against the euro to record levels in the week to February 2. The build-up in net short positions represents more than 40,000 contracts traded against the single currency, equivalent to bets worth nearly $8bn.

Ulrich Leuchtmann, at Commerzbank, says this suggests the euro is vulnerable to a short-term correction higher in the absence of any fresh scares over periphery country finances.

In any case, not all analysts remain so gloomy over the euro’s prospects.

David Bloom, at HSBC, says that even though the US and UK have fiscal problems of their own, the market has focused on the euro rather than the dollar or sterling. “The argument is that Greece does not have the sovereign options of the UK and US to print money or devalue its currency,” he says. “Bizarrely the dollar and the pound are in part rising against the euro because they can devalue or print money.”

Mr Bloom says that while euro weakness seems hard to fight in the short term, over the long term addressing the region’s fiscal problems must be a positive for the single currency against the pound and the dollar.

“It would seem to us the pressure on the eurozone countries to take bitter medicine is increasing but the UK and the US can put off fiscal consolidation because they have a monetary option,” he says. “This is why we are retaining our longer-term bullish argument for the euro.”

Collapse of the euro is 'inevitable': Bailing out the Greek economy futile, says FRENCH banking chief

By Sam Fleming and Tim Shipman
Last updated at 11:29 PM on 12th February 2010

The European single currency is facing an 'inevitable break-up' a leading French bank claimed yesterday.

Strategists at Paris-based Société Générale said that any bailout of the stricken Greek economy would only provide 'sticking plasters' to cover the deep- seated flaws in the eurozone bloc.

The stark warning came as the euro slipped further on the currency markets and dire growth figures raised the prospect of a 'double-dip' recession in the embattled zone.

The bailout of Greece will only act as a 'sticking plaster' for the Euro crisis, the bank warned yesterday

Claims that the euro could be headed for total collapse are particularly striking when they come from one of the oldest and largest banks in France - a core founder-member.

In a note to investors, SocGen strategist Albert Edwards said: 'My own view is that there is little "help" that can be offered by the other eurozone nations other than temporary, confidence-giving "sticking plasters" before the ultimate denouement: the break-up of the eurozone.'

'The euro's a success': Peter Mandelson at Downing Street on Thursday

He added: 'Any "help" given to Greece merely delays the inevitable break-up of the eurozone.'

The alarming claim came a day after European Union leaders promised 'determined and co-ordinated' action to shore up Greece's tattered public finances, but disappointed traders by failing to provide specifics.

Further details are expected early next week, but markets were in high anxiety yesterday amid fears political divisions among rich eurozone members could derail any rescue.

The euro slid almost 1 per cent to $1.357 yesterday, meaning it has lost 10 per cent of its value since November. The pound rose to 1.14 euros.

Earlier this week Business Secretary Lord Mandelson's claimed that the single currency had been a 'remarkable success' and that it remained in Britain's interests to join.

David Cameron ridiculed that claim yesterday.

He told the Tories' Scottish conference: 'Are this Government the only people in the country who still think that would be a good idea? Our deficit and debt are bad enough without the straightjacket of the euro.

'If I am elected for as long as I am prime minister the United Kingdom will never join the euro.'

The French bank's warning was echoed by Mats Persson, Director of the Open Europe think-tank, which campaigns for reforms in Brussels.

He said: 'The eurozone is facing a fully-fledged crisis. The Greece episode has made it painfully clear how flawed the euro project was from the very beginning.

'Even if Greece receives a one-off bailout it would not solve the real problem, which is the huge differences in competitiveness between the eurozone's richest and poorest members.

Tory leader David Cameron said if he is elected, the UK will not adopt the euro

'If these differences are to be evened out, the EU would need a single budget and common taxes so it can redistribute resources.

'One thing is clear, Britain made the right choice in staying out.'

Mr Edwards argued that Portugal, Ireland, Greece and Spain are too economically weak to withstand the rigours of eurozone membership.

Countries that are highly uncompetitive are normally able to slash interest rates and devalue their currencies to prop up their economies.

But this is not possible within the euro, given its one-size-fits-all economic governance.

The implication is that weak, peripheral eurozone members will have to suffer years of painful deflation and tumbling living standards, as well as draconian budget cuts, in order to adjust.

Harvard University Professor Martin Feldstein, a long-standing sceptic on the euro, yesterday said the single currency 'isn't working' because member governments have no incentive to keep their public debts under control.

'There's too much incentive for countries to run up big deficits as there's no feedback until a crisis,' he said.

Germany drags EU back towards recession

Axel Weber, President of Germany's Bundesbank, warned the German economy will contract this year

The eurozone faces the danger of a 'doubledip' recession after Germany's economy retreated into stagnation.

Figures published yesterday revealed that the countries who have joined the euro collectively grew a mere 0.1 per cent in the fourth quarter of last year - equal to Britain's own faltering performance.

Germany was the biggest drag, recording zero growth in the final three months of 2009 after emerging from recession earlier in the year.

Axel Weber, President of Germany's Bundesbank, warned this week there is a chance his nation's economy will contract in the first quarter of 2010, in part because of the severe winter, in a major blow to recovery hopes.

The figures from the European Commission are a blow to Britain's embattled manufacturers, which count the eurozone as their biggest export market.

France provided a bright spot in the report, expanding by 0.6 per cent in the fourth quarter-But Italy, Spain and Greece all registered contractions in their gross domestic product.

Economist Martin van Vliet of ING Bank said: 'The paltry pace of fourth quarter growth makes crystal clear that the eurozone economy cannot yet stand on its own feet.

'The disappointing eurozone growth data are a sobering reminder that recovery from financial crisis led recessions tends to be slow and protracted, and might not prove very supportive in calming markets' fears about the region.'