Euro to make its entrance on tiptoe

Date: 18/09/1997

David Thomas reports on the latest strategy to keep financial markets quiet while introducing economic and monetary union EU FINANCE ministers and central bank governors last weekend signalled a strategy of introducing the euro by stealth to keep financial markets quiet in the run-up to EMU.

Meeting in the Luxembourg spa town of Mondorf-les-Bains, officials said that they would announce bilateral rates for those currencies joining the euro at the same time as the official selection of the countries takes place next May.

This seemed to disappoint the ambitions of the Luxembourg presidency, which wanted to select the first wave countries pre-emptively - as well as set EMU entry rates - at this December's summit of EU leaders.

It also seemed to put an end to Italian hopes of an early 'political declaration' from Union heads of government that their country would make the grade. (Some analysts refer to this derisively as the 'musical chairs' strategy, with Italy seeking to stop the game while it still has a chair to sit on.)

But officials indicated that the decision to announce EMU rates next May was part and parcel of an “incremental” approach to monetary union which means the key features of the currency union will be operational well before 1999. One senior Commission official described this as a “two-step” approach by which the euro would make a “gradual arrival”.

Furthermore, Commission officials suggest there is bound to be a “gradual focusing” on those countries likely to qualify well before next May. These are likely to become progressively known as EU and other official and private sector economic forecasts are published, so defusing market speculation about single currency 'outs' and 'ins' before the spring selection summit.

Comments from Bundesbank president Hans Tietmeyer revealed how the decision on EMU rates next year would almost pre-empt EMU. “We will already have a partial, de facto monetary union from May 1998 on,” he said, adding that this would mean less scope for independent policy action by national central banks after that point.

Although rates will not be irrevocably fixed from May - that will only happen at the start of 1999 - combining the rate decision with the selection, and thus committing central banks to give the currencies concerned their continuing support, will have the effect of insulating them from market speculation. As officials pointed out, it will also commit central banks to bringing short-term interest rates into line.

Wim Duisenberg, current European Monetary Institute president and the likely head of the future European Central Bank, indicated that he believes monetary union is almost here anyway. Asked whether a 'uniform' EMU interest rate would arrive before the start of monetary union, he replied: “This is already happening.”

The fact that central bankers can talk so confidently about their pet project's chance of success reflects the way they have taken the lessons of the 1992-93 EU currency crisis to heart.

This time they are determined not to risk any surprises when ministers and prime ministers meet next year to draw up the list of EMU winners. They want the result to be so well known beforehand that markets will not even twitch a muscle.

The decision not to spell out how entry rates will be determined before the list of EMU countries is settled sensibly avoids giving speculators a target until Union central banks are politically committed to offering each other's currency 100&percent; support.

EU monetary officials admit they are virtually certain to opt to use Exchange Rate Mechanism (ERM) central rates as the single currency conversion method come May 1998. “If you are clever enough to come up with an alternative, we will think about it,” said one Commission official drily. But, in the meantime, the merest hint that there could be an alternative to ERM rates makes speculation a more risky two-way bet for the markets.

Furthermore, officials hope growing market confidence that the euro will be introduced on time and discreet indications that ERM central rates will be the chosen entry method will encourage 'benign speculation', ironing out the problem of the Irish punt, which has recently been pushing up against its ERM ceiling, and maybe also bring the lira back to its central rate.

One could be forgiven a sense of déjà vu about all of this talk of EMU by stealth.

Officials have talked in these terms before - referring to the so-called 'glidepath to EMU' before the crisis of 1992-93 - and were promptly swallowed by their own hubris. Former UK Finance Minister Nigel Lawson suggested that it was precisely this kind of talk which undermined the ERM at that time.

Comments by Bank of France governor Jean-Claude Trichet in Mondorf last weekend suggest that this lesson may not have been fully learnt. He boasted to reporters that the stability of EU exchange rates was almost entirely down to the way they had been “managed”. Management would become even better after EMU rates were announced in May 1998, he added. This prompted wry smiles among reporters. “It's like boasting about 'managing' sunny weather,” said one.

The recent serenity of the markets has more to do with their confidence that EMU will happen because of France and Germany's sheer political determination to go ahead with it no matter how bad budget deficits turn out to be rather than to the management skills of France's Enarques.

Market suspicion that, whatever politicians might say, the euro is indeed going to be somewhat 'spongy' rather than deutschemark-hard has also helped to weaken the mark against the US dollar and dollar-linked currencies, so boosting EU economies and keeping internal strains in the ERM to a minimum.

One EU monetary official suggested the euro's success had been guaranteed by the Union's political failure rather than by the brilliance of its officials.

The inability of leaders to agree a substantial conclusion to the Intergovernmental Conference on EU reform at the June Amsterdam summit, he said, “meant that EMU is carrying the burden of political integration in Europe. After all, what is the point of EMU but to create an economic and political bloc which can compete with and share global power with the US?”

Furthermore, the official added: “This is why it is more urgent that a major economic and political power like Italy has to be inside.”

With economic recovery taking hold across the Union and with normally talkative German opponents of Italian euro membership keeping quiet because of their own budget difficulties, the softly softly approach could allow Italy in almost by default.

In Mondorf, even German Finance Minister Theo Waigel refused to say anything bad about Italy. “We have always had a positive attitude towards Italy”, he insisted. This tone was echoed by Commission President Jacques Santer, who said Rome was at least heading “in the right direction” and had “just as good a chance as France or Germany”.

All this was music to Italian ears. “The appreciation of what we are doing is clearly visible,” said Finance Minister Carlo Ciampi.

“Esteem for Italy has been growing enormously,” insisted Bank of Italy governor Antonio Fazio, who is traditionally more reticent on his country's EMU prospects.

None of this amounts to a single currency endorsement for Italy just yet. Rumblings of discontent from government coalition partner Communist Refoundation during welfare reform talks - the success of which are key to getting the country's budget deficit in order - suggest the country has some way to go before reaching EMU nirvana.

Economic Commissioner Yves-Thibault de Silguy has indicated the country must do more than others to cut its budget deficit because of its massive level of government debt - around twice the criterion laid down in the Maastricht Treaty.

But Commission economists, who intend to release their autumn forecasts earlier than usual this year - in mid- October rather than November - have indicated that the results this time could be good news for Italy, mainly thanks to its strong economic recovery.

EU presidency sources also see forecasts due soon from the Organisation for Economic Cooperation and Development and the International Monetary Fund playing a part in ensuring that the selection of countries becomes gradually known to the markets, thus avoiding a 'Mexican shoot-out' on the subject next spring.

All of this might still go horribly wrong, but not as long as markets believe governments have a strong political incentive to achieve EMU regardless of the size of budget deficits. It no longer depends on how many times they repeat tired mantras about strict compliance with precise economic criteria.