Europe faces only modest gains if yen nightmare ends

By Brian Love, European Economics Correspondent - Analysis

PARIS (Reuters) - Europe's dream of a stronger yen may soon be fulfilled, helping its exporters to defend their global leadership, but gains for the continent's economy as a whole will probably be modest.

If the Bank of Japan raises interest rates in earnest -- a process that could begin when the central bank meets this week -- this may start reversing a trend in which the yen has lost close to 50 percent against the euro in the past five years.

Europe's carmakers, which employ 2.2 million people and face full-on competition in world markets, would perhaps benefit most of all from a yen revival. But the effect on Europe's economy overall would be more like stopping a hemorrhage than providing an infusion of new blood, and other factors are at play.

The value of Japan's currency is part of a growing Asian challenge to Europe as the world's leading exporter. This is led nowadays as much by China, with its vast pool of cheap labor and a currency that is state-controlled, unlike the yen.

Also, just when the yen may be about to reverse course, the dollar is also showing possible signs of becoming a weakling, slipping in recent days to levels that cause concern in Europe, from about $1.30 per euro upwards.

Analysts stress that a yen revival is no cure-all for the European economy. Morgan Stanley's chief Europe economist, Eric Chaney, calculated that a 20 percent yen rise would add just 0.2 percentage points to euro zone gross domestic product.

European exporters need to look further than exchange rates to remain competitive. "Japanese car makers sell their hybrid-engine vehicles in the U.S. market like hot cakes," he said, adding that European carmakers missed this opportunity because they focused on diesel engines.

"In the end, currency rates are no substitute for innovation, even in the car industry," says Chaney.

SLEEPLESS NIGHTS?

Nevertheless, Societe Generale did a few calculations recently that might keep European Central Bank chief Jean-Claude Trichet awake at night, wondering if the bank should keep raising interest rates in its anti-inflation drive -- hikes which tend to push up the euro.

The euro's gains over 2002-2006 reduced exports by 20 percent in France, Italy and Spain from what they would have been had the rise not happened, the bank estimates. That equates to four percent a year in the euro zone's second, third and fourth largest economies. It also reduced exports of Germany, the bloc's biggest member, by 15 percent, or 3 percent a year.

"As the world's leading exporters of manufactured goods, the Europeans have paid a high price for the breakthrough of Asian goods into the world market," the bank said in a research note.

This damage has been masked by the best economic growth the world has seen in decades during precisely the same period, making the pie bigger for all.

The euro has risen about 50 percent against the yen and China's yuan in the last five years, and 36 percent against eight Asian currencies that Societe Generale used for its study.

"The issue of Asian exchange rate policies can be considered to be of utmost importance for Europe, as a major exporter, (and) moreso than the U.S., an importing country above all."