EMU forced on pension funds

German move on government bonds to saddle UK institutions with risks of single currency
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The Independent Online
Pension funds in Britain and across Europe are going to find themselves assuming the risks of monetary union - whether they like it or not - as part of the German government's plans to ensure that a single European currency succeeds and to apply greater pressure on Britain to join it.

Germany's finance minister, Hans Tietmeyer, is understood to have approved in principle the conversion of all existing German government debt from marks to euros when the single currency is introduced in January 1999.

Officially Germany is saying that it will only issue new debt in euros and all existing government bonds will still trade in marks until 2002, the end of the European Monetary Union transition period when the euro will replace all national currencies of participating nations.

But it emerged last week that Germany is prepared to convert its entire bond market into euros at the first stage of monetary union to placate its banking community, which is worried that a two-tier government debt system will hamper the ability of Germany's financial markets to compete with those of France and the UK.

As a result, DM1,400bn (pounds 570bn) of German government bonds will become euros on 1 January 1999. German banks have indicated that they will convert all mark-denominated commercial bonds to euros if govern- ment bonds make the conversion.

According to UK-based analysts, the implications of such a change are huge. Pension funds with large holdings in government debt will find themselves trading predominantly in euros, and it will fast become the currency of choice for settlements throughout European markets because it will be the currency with the greatest liquidity.

"If the Germans make the changeover and put the weight of their government debt behind the euro, it will certainly speed the wide use of the euro in all market transactions," one analyst said.

Other observers believe that there is a strong political motivation behind the change. According to Mark Fox, chief European strategist at Lehman Brothers, placing large amounts of euro-denominated paper in institutional portfolios will force markets - and by extension governments - to back the new currency. "It is a very clever shift of risk to the private sector," Mr Fox said. "Pension funds will in effect be co-opted into backing monetary union whether they want to or not.

"It will be one of the most effective ways to ensure that their is no disruption to monetary union. The political tension over whether this currency experiment will actually go ahead or not will ease as soon as people realise that if EMU fails it will hit them in their pockets."

Mr Fox also said that the size of Germany's government bond market - around one-and-a-half times bigger than the UK's - will enable it to assert a dominant influence in Europe's capital markets if it adopts the euro right away.

France and Belgium have already committed themselves to convert all their debt into euros when the single currency comes into existence, but their government bond markets are small by comparison.

It is also believed that Germany wants to use the clout of its euro-ised bond market as an added safeguard against wayward budgeting by other EMU member countries.

So far it has managed to get agreement in principle on a "stability pact", which will limit budget deficits to within 3 per cent of GDP.