Parity with the dollar is no disaster for the euro

News Analysis: Few experts would bet against it but fewer still think it is anything but a symbolic barrier
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THE CURRENCY markets paused for breath yesterday in their apparent determination to push the euro below the $1 level, but it would take a brave pundit to predict that the new European single currency will not hit that psychologically important level before long.

"It is being driven lower by fundamentals," said Paul Mortimer-Lee, the chief economist at Paribas. "Why try to resist the tide?"

Horst Siebert, the head of the prestigious Kiel Institute for World Economics and an adviser to the German government, caused another brief wobble yesterday by suggesting that the euro would fall as low as 90 cents.

Yet few financial market analysts think breaching dollar parity has anything more than symbolic importance. "We should only care if breaching the round number would undermine political support for the euro, or if it would lead to turbulence in the financial markets," said Mr Mortimer- Lee. "Neither of these is the case."

In fact, for all the excitement about the currency falling to new "lifetime lows" every other day, it is just a little lower against the dollar than its component currencies were in 1997. And the depreciation of the euro against the US currency since 1 January is put in the shade by the fall in its predecessor currencies in the early Eighties. If the euro had existed then it would have fallen from $1.45 to $0.68 from peak in 1981 to trough in early 1985 - a 53 per cent decline. The 15 per cent fall since 1 January still looks very modest by comparison.

Now, as then, a large part of the explanation for euro weakness lies in dollar strength. Sterling and the yen have also declined recently against the mighty greenback.

The euro's trade weighted index against a range of currencies is down just 8 per cent since its formal launch on 1 January, and in April-June was only 5 per cent below the 1998 average. It has actually started to appreciate against the pound, which has experienced a greater decline against the US currency in the past month.

Most analysts find the dollar's strength mysterious, given the size of the US trade deficit. What's more, the differential between US and other bond yields has narrowed as yields in euroland have risen in recent weeks, making dollar assets less attractive.

"Bad news for the dollar is what will get the euro off the ropes, although obviously there is a good chance the market will have a crack at parity meanwhile," said Mark Cliffe, chief economist at ING-Barings.

It is hard to find any great concern about the possibility the euro will pass parity, at least outside the Bundesbank, where the old strong currency habit dies hard. Certainly officials from the European Central Bank have made it clear there will be no intervention to support the currency unless its depreciation becomes disorderly. The ECB's monthly bulletin earlier this week made it clear the central bankers thought inflation pressures were absent despite the weakening currency - although adding cautiously that prices would be monitored carefully for any signs of upward pressure.

"A weak euro doesn't matter as long as it does not pose an inflation risk. What are we worrying about? We are getting growth in Europe without any inflation," said Michael Dicks, European economist at Lehman Brothers.

He said downward pressures on prices, thanks to the reinforcement of the single market by the single currency, would further reduce the risk of any pick-up in inflation.

Mr Mortimer-Lee agreed. "A strong currency is one that keeps its purchasing power, and the euro has. Prices would probably be falling in France and Germany if it were not for the exchange rate," he said.

Many economists expect the euro's weakness to prove self-correcting anyway. For one thing, it will make euroland exports more competitive, and thus boost growth in the export and manufacturing sector.

Secondly, the increase in euro bond yields ought to tempt investors back into the currency. "There are market opportunities which will eventually bring the currency up once people in the markets get past the psychology of the round number," said Mr Dicks.

Paul Meggyesi, currency strategist at Deutsche Bank, said some investors had started looking to buy euros for the first time in some months, but he was sceptical about whether the weaker euro alone would boost European growth.

"A lot of US investors have had enough and been selling euros because of the incessant decline in the currency. That is what has driven bond yields higher." These higher long-term interest rates could dampen investment and consumer spending, Mr Meggyesi said, meaning the weak exchange rate will not necessarily be beneficial for growth.

However, consensus forecasts for growth - especially in the feeblest economies, Italy and Germany - have been revised up. Most experts forsee a steady and even strong recovery in the heart of euroland in the second half of this year.

Analysts have therefore started to look ahead to the prospect of an increase in interest rates from their current low level of 2.5 per cent on the Continent, with spring next year tentatively pencilled in for such a move.

The ECB's monthly report said: "New data point to a stabilisation of overall output growth in early 1999 and to an economic recovery in the second part of 1999 and into the year 2000." The financial markets are looking for Wim Duisenberg, president of the ECB, to signal after its council meeting today the possibility of an upward move in interest rates if the economy does recover as expected.

These changing economic fundamentals, rather than any attempt by politicians to talk up the currency or any fear of intervention, will be what eventually turns the tide on the foreign exchanges.