Tietmeyer underlines German commitment to a strong euro

Yvette Cooper reports on the debate over whether Europe's new currency will be weak or robust
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Hans Tietmeyer, president of the Bundesbank, yesterday warned it was "premature and unjustified" to believe the euro would be a weak currency just because European currencies have depreciated against the dollar in recent months.

Speaking at a conference on monetary union, held by Goldman Sachs in Frankfurt, Mr Tietmeyer reiterated Germany's commitment to a strong stable currency. He said: "We in Germany are interested in the mark remaining a stable currency and in the euro being similarly stable and strong."

But he warned against irresponsible fiscal policy by member states, something that the Bundesbank believes is a serious threat to the strength and credibility of the new currency.

The fact that Mr Tietmeyer felt the need to defend the potential strength of the new currency in the light of the dollar's appreciation reflects the emerging doubts in Europe that the euro will be a strong currency at all - doubts that many analysts believe will prove unfounded in the long run.

Robert Lind of ABN Amro said: "We suspect the euro will be a weak currency ... people have switched from talking about a `strong' euro, to talking about a `stable' exchange rate instead. That is very significant."

According to Mr Tietmeyer, the recent depreciation of European currencies is not, in itself, a sign that the new euro will be a weak currency once established. "Current exchange rate relations doubtless better reflect the fundamental economic data on both sides of the Atlantic," he said.

As Julian Jessop from Nikko Europe explains: "Whether a currency is strong or weak depends a lot on the stage of the economic cycle." The US economy continues to grow strongly, while many European countries are suffering sluggish growth and high unemployment. Furthermore, the fact European governments are tightening fiscal policies to meet the Maastricht criteria means looser monetary policy is inevitable to stop European economies grinding to a halt.

But the more important question - and the greater fear for the Bundesbank - is whether the euro will continue to be weak across the economic cycle. According to David Mackie of JP Morgan, "currencies over the long term tend to follow relative inflation performance". The strength of the mark over the last few decades reflects Germany's low inflation performance - something made possible not least by the Bundesbank's hawkish zeal.

The European Central Bank has been heavily modelled on the Bundesbank. The Maastricht Treaty makes clear that its goal will be price stability, and that it must be free from political interference. Nevertheless, it will lack the Bundesbank's long record of credibility.

More important, many fear that the new ECB will not be as hawkish as the Bundesbank, especially if Italy and Spain join too. In a recent report for the Economist Intelligence Unit, David Curry writes: "There is a concern that if and when the membership widens, the governors of central banks from more inflation-prone countries could take a less robust line on limiting inflation."

But Mr Mackie believes such fears are overstated. He points to the fiercely hawkish record of other European central banks in recent years. "The Bank of Italy is behaving in an extraordinarily hawkish way - in some ways more so than the Bundesbank." He adds: "There has been a cultural change. No one believes there is any virtue in a burst of inflation."

Mr Tietmeyer's own concern is that European governments will wreck the euro zone with fiscal profligacy, no matter how well-intentioned the ECB. High borrowing by undisciplined member states could push up interest rates across Europe and weaken European economies. Mr Jessop said: "Other things being equal, the better the fiscal position in the long term, the stronger the currency will be." However, he added that a balance had to be struck; if fiscal policy was too tight, restricting governments' ability to cope with economic shocks, then the euro zone could be weaker, and the currency weaker too.

Mr Lind has a more deep-rooted reason to believe the euro might be weak, if Italy and Spain join. "Look at the underlying fundamentals. Italy and Spain will find it hard to cope with a strong currency - their labour markets are not efficient enough, and their corporate sector is not competitive enough." The strength and sustainability of the euro in the long term will depend on the speed with which member states' economies genuinely converge. According to some analysts, Italy and Spain cannot expect a sympathetic ride from France and Germany either. Mr Lind suggests the French and Germans are keen to ensure the exchange rates at which member states lock together in 1999 are favourable to the French and German economies. But Mr Mackie is sceptical about the extent to which countries will attempt competitive devaluations in the run up to EMU. "The Maastricht criteria make it too difficult, and every country has an interest in a smooth, stable transition."

According to Mr Jessop, if these transitional problems are dealt with, and EMU succeeds, "the euro could become a very strong currency".

The sheer size of the euro zone will, according to Mr Jessop, make it an attractive alternative to the dollar as a reserve currency for countries holding foreign reserves.

And he suggested that "the euro could eventually become the new global reserve currency".