The big story in the currency market today is the euro which hit a 2-month low against the US dollar. Ratings agency Moody’s warned that the exposure of Western European banks to Eastern European loans could affect their credit ratings. Up until the global credit crisis, Eastern European nations were growing at very rapid rates. This enticed many Western European banks to lend as much as $1.7 trillion to those nations. According to Morgan Stanley’s Stephen Jen, $400bn of that debt is expected to be rolled over this year - about a third of the region’s GDP.

On top of that, many companies in Eastern Europe were sold foreign exchange contracts to protect them against appreciation in their currency. Poland’s Polsi Koncern Meisny Duda SA (a meatpacker) reported that their currency derivatives contracts have floating losses of 29.3 million Zloty ($7.8 million). They wanted to hedge against a higher currency but instead, the zloty plunged 33 percent. Similar problems are expected for other Eastern European corporations. This could be a domino effect that hits the region as a whole.

Within the Eurozone, there is still fear that Ireland could default on their debt as credit default swaps hit record highs. A default in Ireland will add tremendous pressure on the Euro.

All of these problems brewing in Europe will mean more losses for European banks. This could force the European Central Bank to take more aggressive action on a monetary basis and drive the EUR/USD down to its 2-year low of 1.2330.

Kathy Lien is Director of Currency Research at GFT, and runs KathyLien.com.