The European single currency is in danger of breaking up without wider political integration, a top adviser to the president of the European Commission warned yesterday.
Paul De Grauwe, a Belgian economics professor who advises Jose Manuel Barroso, said the situation in the wake of the rejection of the proposed EU constitution by French and Dutch voters was "dangerous".
"Without political integration the eurozone is a roofless house, that becomes increasingly uncomfortable," he told a Belgian newspaper. "Many inhabitants will want to leave the house sooner or later. The euro does not offer clear advantages to some countries and is considered there to be a source of economic slowdown."
The warning came a day after a German magazine claimed the country's finance minister and central bank governor have discussed the possible failure of the entire European monetary union project.
The authorities were quick to deny the story, with Hans Eichel, the finance minister, describing the idea on Wednesday as "absurd". Jean-Claude Trichet, the president of the European Central Bank, picked up the theme yesterday, saying: "I don't comment on absurd questions ... yes, complete nonsense."
Caio Koch-Weser, Germany's deputy finance minister, said: "It's totally crazy to claim the euro is a burden on the economy. It has been a success story."
The denials did little to calm speculation of a break-up of the eurozone, with many analysts saying Germany's economic problems made it a prime candidate. The euro plunged more than 2 per cent after France's vote to hit its lowest level for eight months against the dollar. As Stephen Lewis, the chief economist at Monument Securities, put it: "The fact that officials are not taking it seriously suggests we should."
Since the euro's launch in 1999, Germany has laboured under a high conversion rate from the old mark and from a much higher real interest rate than the Bundesbank would have run. "Germany could come to the conclusion that it had made a big mistake and that tinkering around the edges won't help," Mr Lewis said.
According to Michael Rottmann, the head of foreign exchange strategy at HVB Corporate and Markets in Frankfurt, German growth and inflation pointed to the need for an interest rate of 1 per cent rather than the ECB's 2 per cent. "If the economic performance continues to diverge further there will be some discussion somewhere down the road," he said.
Some go even further. Stuart Thomson, the chief economist at the stockbroker Charles Stanley Sutherland, said history showed monetary union could not exist without political union. "The failure of the EU constitution increases the probability that fiscal imbalances will cause the single currency to fall apart by 2020." He said the mounting pensions problem could cause the union to disintegrate as soon as 2020 as baby-boomers retire and reject solutions such as higher taxes or longer working lives. However, Mr Thomson said it could be triggered sooner rather than later if the dollar were to tumble and the euro surge."Countries such as Italy, Portugal and Greece that would have used devaluation as an escape valve are unlikely to be able to live with a sharp rise in the euro."
The Commission is planning disciplinary action against Italy next week for breaching EU budget deficit rules. Nick Stamenkovic, at RIA Capital Markets, said. "Italy has a poor fiscal position and a competitiveness problem and the constraints of the euro mean it will have to cut costs aggressively, and that means keeping inflation low."
The alternative pulling out of the euro could be equally painful. Julien Seetharandoo, an international economist at Capital Economics, said: "Leaving the euro would leave Italy with national debt interest payments which would dwarf any advantage of a competitive devaluation."
Most economists believe that while it would have a huge impact, the probability of a break-up of monetary union is low. "Politicians like to change any rule they want," Mr Rottmann said, pointing to the unilateral decision by France to widen the franc's band within the exchange rate mechanism when it was attacked by speculators. "Politicians like to see further integration, that is to say it is unlikely there will be any change."
Mr Lewis said practical difficulties in disentangling euro-denominated financial claims would be a "severe deterrent".
There are signs that markets are taking notice of the dangers. The spreads between interest rates on different countries' bonds have widened in the past few days, implying that investors are beginning to identify those countries more at risk from the turbulence.
Patrick Jacq, a fixed income analyst at BNP Paribas in Paris, said: "So far spreads have been affected by bad news on fiscal imbalances to the benefit of core markets against peripheral countries. But growing uncertainty on the future evolution of the EU could affect some core markets such as France."
The ECB showed no sign yesterday of an imminent move to cut rates to take pressure off Germany. "If I was preparing for a rate cut, I'd tell you something which would permit you to think that," M. Trichet said. However, the bank cut its growth and inflation forecasts, which analysts said was a precursor to a rate cut. Mr Lewis said: "The referendum results most likely represent the beginning of a time of troubles for EU institutional arrangements, including those relating to the euro, not an end to uncertainty."Reuse content