EMU - the big European bond turn-off

Click to follow
The Independent Online
The global investment community is losing faith in the likelihood Europe can introduce a common currency, on schedule, on 1 January 1999.

A Bloomberg subscriber survey, including more than 280 fund managers, shows just 59 per cent of the 1,427 respondents expect European economic and monetary union to go ahead as planned.

Moreover, confidence in the prospects for EMU has slumped in recent months, with 70 per cent of respondents saying they were expecting Europe to stick with its EMU timetable six months ago.

"The dangers are growing," said Andrew Milligan, the senior economic adviser at GA Investment Management. "The chances of some sort of forced delay, or a managed delay, are quite considerable, and are rising."

The poll, taken between 2-10 June, shows European finance professionals, who accounted for about 62 per cent of replies, are more optimistic about EMU's prospects than their US counterparts, who comprised about 20 per cent of the survey.

While 64 per cent of replies from European clients see EMU on track, just 45 per cent of US subscribers expect it to happen on time, dragging down the average expectation.

What should prove worrying for European leaders assembling in Amsterdam for the summit meeting which begins Monday, however, is the collapse in European hopes about EMU. Some 76 per cent of European clients said they'd have voted for the single currency happening as planned, if they'd been polled six months ago - showing a 22 percentage-point drop in support.

The survey also shows a Europe/US split on the likelihood of some of the weaker European economies making the grade for EMU.

While more than half of European respondents expect Italy, Spain and Ireland to be among the first group of countries in the single currency if it goes ahead, less than 50 per cent of the US subscribers who replied see those three countries participating in a 1999 euro.

In the global results, only 45 per cent of respondents expect Italy to be using the euro in 1999, though Spain edges in with 53 per cent, and Ireland makes it with 58 per cent.

The latest bout of EMU jitters was sparked when France's Socialist coalition won power at the country's national election at the beginning of the month.

Analysts attributed the victory to voter discontent at France's economic belt-tightening efforts to meet the 3 per cent budget deficit limit demanded of countries joining a single currency - a sign European citizens are not as committed to the single currency project as their political leaders.

With French unemployment stuck at a record high of 12.8 per cent, one of the first moves the new government has taken is to demand a pact to create jobs in Europe - otherwise, it says it won't sign the so-called stability pact

A German government plan to revalue gold and foreign currency reserves to help cut its budget deficit sparked a row with the Bundesbank, increasing concern that the future European Central Bank won't be able to fulfil its mandate of ensuring stable prices without political interference.

"It's a political scandal," said Jurgen Karl, manager at Helaba Invest in Frankfurt. "The ECB should follow the same course as the Bundesbank, but suddenly the independence has been brought into question and that's a big concern."

Earlier this week, the Organisation for Economic Co-operation and Development said both France and Germany will post deficits of 3.2 per cent this year, which would bar them from joining a single currency if the economic criteria are strictly enforced when the group of entrants is chosen.

"Nobody except politicians thought they were going to make it," said Roger Monson, chief equity strategist at Daiwa Europe, who added that the OECD is "just stating the obvious".

Another landmine on the path to the common currency: Germany's constitutional court has ruled Germany must abide by a "strict" reading of the economic targets, with several German citizens, including ex-lawmakers, saying they'll take the government to court if the rules are relaxed to keep the project alive.

If politicians do manage to get the euro introduced in 1999 by fudging the rules on which countries qualify, they'll be ensuring the new currency is weak, economists said. Almost three-quarters of the survey respondents expect that to make US bonds a better buy than the debt of European bonds in the years ahead.

German 10-year bonds, Europe's benchmark, currently yield 85 basis points less than 10-year US Treasuries. That spread, a measure of the additional value investors perceive in the German market, has been dropping in recent weeks, and is down from above 100 basis points at the beginning of May.

The average forecast of respondents to the survey was for that spread to halve to about 42 basis points by 1 January 2001.

For global fund managers, the prospect of a single currency is a turn- off for European bonds.

"We have to be cautious with our pensioners' money," said Andrew Milligan, the senior economic adviser at GA Investment Management.

"The EMU outlook is so uncertain and complex, with so much rumour and volatility in the markets, there's a lot to be said for going for nice safe havens one understands, where economic fundamentals count for something and can be analysed. Japanese government bonds, Swiss franc debt, gilts, Treasuries, anything but the bonds of core EMU countries." Copyright: IOS & Bloomberg