With less than 100 days to the birth of the euro, time is short for borrowing rates in the 11 participating nations to converge. Two crucial questions remain outstanding: what rate will the European Central Bank set when it assumes power to do so on 1 January? And how will the countries furthest away from the magic number achieve convergence without creating financial ructions at home?
Several nations, including Italy, Spain and, most of all, Ireland are out of line with the European average and their central banks face a dilemma.
In effect, they have two alternatives, either to begin a gradual reduction in interest rates, or to wait as long as possible with higher than average rates, (thereby squeezing inflation), and opt for a "big bang" reduction at the end of the year.
The scale of the difference they need to bridge remains imprecise and, consequently, their strategy can only be worked through by an elaborate system of nods and winks. That, of course, is what informal meetings of finance ministers and central bank governors are all about. As one Ecofin veteran put it: "These meetings are, as the title suggests, informal. An awful lot is done over drinks and social occasions."
Until 1 January, the central banks of each country have sole responsibility for setting their respective rates. Nor do they know exactly what figures they will have to hit for EMU. But they do know, as one European Commission source put it, that "by the end of the year these differences will need to be eliminated".
To complicate this elaborate game of second guessing, the European Central Bank has not yet declared what indicators will be used to guide its interest- rate strategy. Its remit is to maintain "price stability", in other words controlling inflation, but its mechanism for achieving this has not been decided. At its Frankfurt headquarters, doubts persist as to whether the ECB will be able to gather sufficiently accurate data on inflation in Euroland to target it the way that the Bank of England, for example, does.
The alternative is to opt either for a system that targets monetary aggregates or - most likely - a hybrid that combines the two.
Yet the broad parameters remain clear, and they spell potential trouble, particularly for Ireland. In an interview in Greece last week, the ECB President, Wim Duisenberg, said that rumours that the bank "will endorse a high interest rate policy are groundless". He added that while the bank's monetary policy is still open, "there is no reason not to adopt a policy similar to France's or Germany's".
Although long-term rates are converging throughout the continent, there remains a big disparity among short-term rates in the 11 member states. At Dresdner Bank in Frankfurt, the current prediction is that the ECB's repo rate will be 3.5 per cent on 1 January, 1999, close to Germany's current equivalent of 3.3 per cent. Indeed, the bank thinks it may revise this downwards, perhaps to 3.3 per cent, in the coming weeks.
This is in line with predictions from Salomon Smith Barney in London, which expects a rate of 3.3 per cent. That means central bankers in several countries will need to take action. Spain's rate is 4.25 per cent, Portugal's slightly higher at 4.5 while Italy is just over 5 per cent. Highest of all is Ireland with a rate of more than 6 per cent.
This poses problems for each nation, most of which would like, for their own domestic reasons, to keep money as expensive as possible for as long as possible. In Spain and Portugal, growth in inflation is seen as a threat. In Italy, although economic growth is not particularly high, the central bank governor, Antonio Fazio, is worried that money growth presages an upsurge in inflation.
But for Ireland the scale of the problem is greatest and most dangerous. With economic growth high, the government under pressure to deliver tax cuts, and the housing market booming, there are acute worries about inflation.
A cut of more than 3.5 per cent in the cost of borrowing is hardly what economic purists would have wanted.
Earlier this year, hopes were high in Dublin that there would be an upward movement in average European rates leaving a smaller gap to bridge. But given the growing fears of world recession, the pressure is in the other direction.
Dr Rolf Schneider, head of macro-economic research at the Dresdner Bank, argues: "This will produce difficulties, particularly in the Irish economy, which is stronger than the European average. It is a problem for them to reduce interest rates in this situation. I expect the ECB to start with a level near those of Germany and France."
With house-price inflation in Ireland reaching 40 per cent, the preference of many was to maintain a high interest rate policy for as long as possible, in the hope of squeezing as much inflation as possible from the system before January. That appears not to be the favoured option of the ECB and fellow central bankers who are applying discreet pressure for small, staged reductions in interest rates from October onwards.
Leaving matters to the end of the year would, goes the argument, add an element of risk and uncertainty which could hardly be welcomed in the current turbulent state of the world economy.
The proponents of the gradualist strategy argue that many of the effects of interest rate reductions will not be felt. For example, mortgage lenders are unlikely to pass on the full benefit to consumers. Thus fears that the housing market will over-heat are exaggerated.
Most of all, the shocks to the world economy have changed the climate. With Italy's growth forecast being revised downwards on Friday, the pressure on the Bank of Italy to cut its borrowing rate increased.
That was just a sign of things to come. Mr Duisenberg made clear this weekend that he was expecting growth in the EU in 1999 to be 2.5 per cent, rather than the 3 per cent predicted in March.
Jose Alzola, European economist at Salomon Smith Barney in London, argues: "Up to a few months ago, it was obvious that a rate of 3.3 to 3.75 per cent would be too low for some countries - Ireland, Spain, perhaps Finland and the Netherlands. In current conditions, I think this is less of a risk. I think a level of around 3.3 per cent will be sustained through much of 1999. There are still risks of over-heating in some peripheral countries, but the risks are obviously lower than a few months ago because of the less inflationary environment in the world economy."
In Vienna yesterday, one diplomat put the same thought in a rather blunter way. Staged cuts in interest rates are, he argued, more manageable now for one very simple reason: an imminent world recession.