Nice work, Wim - now for the long haul

News Analysis: The euro may be bouncing back, but these are early days in a 10-year project
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The Independent Online
EUROPE HAS closed for business for the summer holidays, and one of those most in need of a break is Wim Duisenberg, president of the European Central Bank (ECB).

Few will begrudge him his holiday in France. Less than a month ago the euro seemed destined to reach parity with the dollar, marking a symbolic humiliation for the infant currency and its creators.

Yet Mr Duisenberg has weathered the storm, and now finds the picture looking rather more rosy. Within a matter of days, pressure on the currency eased amid rising economic confidence in Germany. The euro escaped falling to dollar parity and even bobbed up past the $1.08 level, seen as a key psychological mark by the currency markets.

Even the sternest critics of the euro are beating a tactical retreat. The Daily Telegraph recently published an article arguing that a stronger euro was no more desirable than a weak one. And once again the talk is of European economic resurgence.

But is the new perception of Euroland's strength likely to last any longer than the once-universal market pessimism? Certainly it reflects a wealth of good economic news about the prospects for the 11-nation euro bloc. The last ECB meeting coincided with the release of France's Insee general business outlook, which jumped to 13 in July from minus 10 in June.

The study echoed the findings of a similar business confidence survey published a week earlier in Germany. This week has brought further confirmation of improvement with news of an upturn in Europe-wide business confidence.

Optimism about prospects for Euroland ranges further afield. The European Commission's latest private assessment of the economic outlook is better than it has been for months. Surveying its forward indicators, the Commission concludes that, in most member states, order books, industrial productivity and/or retail sales are up.

Employment news is good with Belgium, the Netherlands, Ireland and Finland making strong progress. Following statistical adjustments, the labour market conditions in Italy look better than had been feared. Moreover, Commission economists conclude, the downward trend in inflation seems to have stabilised.

Most significant is the reviving confidence in Germany, which will inevitably be the dynamo of any sustained European economic recovery. At Frankfurt's Dresdner Bank, Dr Rolf Schneider, senior economist, is feeling more bullish than he has for months. The improvement, he argues, is not homogeneous; recent figures for industrial equipment, for example, buck the trend by showing a downturn. Yet the general picture is healthy, with export demand improving in April and May and impressive growth in eastern Germany, albeit from a low base.

"Not all figures will be positive," says Dr Schneider, "but the trend is positive. We believe GDP will rise quite strongly in the third quarter. We predict that growth will be 2.2 to 2.3 per cent next year. If there is a correction to that estimate we would expect it to be upwards."

If the improving mood in Frankfurt has helped the euro, other factors have also contributed. First, there is a realisation that the markets overdid their negative comparison between the euro and the dollar. Despite worries about Germany and Italy, the fundamentals of the European economy were hardly dire; indeed, five of the 11 euro zone countries have been growing at more than 3 per cent.

But with Germany struggling with a growth rate of less than 2 per cent, perceptions of a sizeable gulf between the euro 11 and the United States prompted the run on the euro, which assumed a self-fuelling quality. The lower the euro sank towards $1, the greater the temptation for the markets to test whether they could provoke a change of ECB policy or a selling spree.

The architects of the euro now feel they have witnessed two important historical phases and survived: the value of the euro was first buoyed by optimism at its launch, before which the value of its component currencies had soared. Then came the market rebound. Now perceptions have begun to change; while US economic growth continues to outstrip that of Europe, there are signs of a slowdown. Concerns range from worries about the current account deficit to fears that stocks are highly overvalued.

These have coincided not only with good economic data in Europe, but also with a hint from Mr Duisenberg that the ECB could be leaning towards increased rates. Dr Schneider says: "The most important reasons for the improvement of the euro are the economic news, and the announcement from Mr Duisenberg of the possibility of interest rate rises."

Perhaps more significant are other, more fundamental, reasons for the rise in market confidence in Europe, in particular indications that the euro zone may be starting to tackle some of its structural problems. The departure of Oskar Lafontaine from the German government has allowed the Chancellor, Gerhard Schroder, to refocus his agenda on more business-friendly reforms.

The latest Italian budget proposals indicate that the government in Rome is planning a significant budgetary correction. Earlier this summer the markets took fright when the Italian government announced that its deficit for 1999 might reach 2.4 per cent, rather than the 2 per cent it had planned. Yet its latest plans suggest the government will stay on course to reduce the deficit to 1.5 per cent in 2000 and 1 per cent the year after. This implies some substantial measures, including a serious attempt at pension reform.

Encouraging, too, are indications that recovery is being driven by demand from within the Euro-11 zone. Tough action on public finances by participating member states as they prepared for euro membership seems to have released funds elsewhere in the European economy.

Aware that euphoria may be as premature as the gloom of last month, one senior Brussels source last week cautioned that "one butterfly does not make a summer".

The signs may be good, but it is simply too soon to say whether Europe has got to grips with structural reform. This, after all, is a five or 10-year project. And, as Mr Duisenberg well knows, market perceptions can change in rather less time than that.