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Euro appreciation against sterling would bring problems too Back  
Robin Aspinall was in Dublin earlier this year to pick up local intelligence on the Irish economy and to share views on the Euro, Sterling, Ireland and the UK with clients of National Irish Bank. Here he offers some reflections on those themes.
As a confirmed euro-sceptic it has been hard not to take just a tiny amount of satisfaction from the euro’s plight during its early months. But, of course there are important issues associated with the euro’s performance, not least for Ireland, where euro weakness has contributed to over-heating and accelerating inflation.

In a sense the euro has been a victim of its own success. Before it was even launched there was such an overwhelming degree of optimism and enthusiasm for the concept - particularly from the Japanese - that there had been massive buying of euros ahead of January 1999. Little wonder, then, that such sated markets had little appetite for more euros once EMU had become a reality.

Opacity and transparency

But the euro’s continuing dismal performance demands more of an explanation, and most of that lies with the european Central Bank. The criticisms of ECB policy have included its lack of ‘transparency’ and, especially, the inconsistency of the messages from its members. Much of this criticism has been unfair.

Take transparency. In the UK we have about the most transparent monetary policymaking possible: the Monetary Policy Committee’s minutes and voting record are published just two weeks after each decision, and each member is required to explain his/her actions to parliament on a regular basis. Yet this has led to much media exposure of individual members and, inevitably, has given the frequent impression of disagreement, fragmentation and uncertainty.

In principle the ECB approach should be better. By keeping its meetings and voting secret it can hope to maintain a fa?ade of unity. There can be much public discussion by ECB members before the meeting; everyone is aware that there is debate and disagreement within the ECB; but when the decision is announced it is seen as being a decision of the institution as a whole rather than the few individuals who voted for it.

Problem is EMU, not ECB

If the ECB is viewed as slow, indecisive and opaque the heart of the problem lies not with the ECB but with the concept of EMU itself. The attempt to weld 11 diverse economies into a monetary institution where 17 individuals are required to reach a consensus was always likely to be fraught with difficulties and fractiousness. These problems are amplified by the fact that, when it comes to the euro, any decisions also have a political dimension. And the politicians have been even more vociferously divided than the ECB’s council members.

The dismay caused by a plethora of often contradictory public statements and the juggernaut style of decision-making has undoubtedly undermined the ECB’s credibility and faith in the euro itself. That has not been helpful, but its true significance needs to be seen in terms of the broader global picture.

The euro is now vying with the dollar and the Yen as one of only three mega-currencies. While, on its day, the euro/Yen relationship can be the driving force in the currency markets, more usually it is the euro/Dollar relationship that dominates. Hence it is a truism that the euro can only recover if the dollar weakens.

Dollar and ‘the Street’

We have seen on several recent occasions that the dollar looks most vulnerable on those days when Wall Street has wobbled. Indeed, it is generally accepted that the fate of the dollar is closely integrated with that of the other US financial markets. So a likely scenario for a euro recovery would involve turbulence in the US financial markets, and the associated implications for global markets and the world economy.

Euro upturn mixed blessing

The line of reasoning can be readily extended to sterling’s relationship with the euro. Two observations are relevant here. One is that sterling has been remarkably stable against the dollar for the last three or four years. It is almost as if sterling had joined an ERM arrangement with the dollar. That is not altogether surprising since the UK and US economies share strong Anglo-Saxon characteristics. The UK is much more ‘convergent’ with the US than with the euro-zone. (The same, surely, is true of Ireland, which partly explains the economic tensions now emerging.)

The second observation is that the euro and euro-linked currencies comprise around 70% of UK trade (and, therefore, the trade-weighted measure of sterling that the Bank of England monitors). The arithmetic of all this is that for sterling to fall against the euro, the euro must rise against the dollar.

Hence the uncomfortable conclusion is reinforced. One of these days the euro is going to recover strongly against the dollar and against sterling. I would not be surprised to see a rebound of 10-20%. But in my view the most likely trigger for that rally will be another bout of global turbulence, this time centred on the United States. For all the problems that euro weakness/sterling strength may be causing the Irish economy, the alternative may not be as welcome as it seems.

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