If you're worried by the freefalling euro, take a holiday on the Continent

Click to follow
The Independent Online

The financial markets have been having a lot of fun at the euro's expense, with analysts competing to come up with the most outrageous prediction of just how far the tattered currency can fall. It lost another cent against the US dollar during trading yesterday, hitting a new low of 88.48 cents before clinging on to a level just above 89 cents. Many pundits in the City of London pronounced that it could soon reach 80 cents. One bold soul went for the 50-cent euro.

The financial markets have been having a lot of fun at the euro's expense, with analysts competing to come up with the most outrageous prediction of just how far the tattered currency can fall. It lost another cent against the US dollar during trading yesterday, hitting a new low of 88.48 cents before clinging on to a level just above 89 cents. Many pundits in the City of London pronounced that it could soon reach 80 cents. One bold soul went for the 50-cent euro.

Away from the playground of the City's markets, serious commentators discuss the weak euro (and its counterpart, the strong pound) as if its problems could be traced to specific real events. So among the candidate explanations for the fact that the single currency has lost 25 per cent of its value since its launch on 1 January 1999 are: the near-miraculous economic growth in America; the large investment flows out of Europe; the lack of credibility of the European Central Bank; and the snail's pace at which many Eurozone governments are introducing necessary economic reforms.

There is something in each of these explanations, any of which would tend to make the euro weak, vis-à-vis the dollar. But they have all been true for as long as the euro has existed, so none can explain the recent nosedive.

In fact, the steep decline in the currency is a typical financial market overshoot. The foreign exchanges are, after all, an extension of the stockmarket and therefore just as prone to over-reaction. Pushing the euro lower and lower looks like a safe bet when it is falling so fast, while it would take a brave trader to gamble right now on an imminent recovery.

There is nothing fundamental to be inferred about the relative strengths of the Anglo-Saxon and Continental economies, or at a further remove about the politics of the Eurozone, from the exchange rate swing, however. The kind of misalignment now evident in the markets, with the over-strong dollar and pound and under-valued euro, occurs about once every decade.

For most of the first half of the Nineties the pound was extremely weak. It had been massively over-valued in the early Eighties and was undervalued by the middle of that decade when one pound would buy only just over $1. The desire to escape such regular and damaging fluctuations was, after all, one of the motivations for the creation of the single currency in the first place.

Often these dramatic swings are turned around by central bank intervention, cleverly timed. There is now some pressure on the European Central Bank to intervene directly in the markets by using its reserves to buy euros. It would be a risky strategy, however, unless the authorities could be sure it was going to work. The Bank of England could advise its counterpart in Frankfurt, drawing on its own dismal experience in trying and failing to defend the pound in September 1992, that there is nothing more damaging to either the balance sheet or the reputation than failed intervention to prop up a weak currency.

As one City expert, Mark Cliffe at ING Barings, put it yesterday: "If the ECB intervenes and fails, its credibility will be shattered, and it is bad enough to start with."

The rumour that there had, nevertheless, been some official action swept the currency markets yesterday, helping halt the euro's dive. Yet one common feature of all successful interventions in the past has been co-operation from the United States. Since, for now, the US Treasury is thankful that the dollar has been strong enough to help keep the lid on imported inflation as the American economy powers away, there is no reason to believe that such co-ordination is imminent.

Looking on the positive side, this is a fantastic time for Britons travelling to the Eurozone for a holiday or planning to buy a second home in the Normandy or Tuscany countryside. It's a great time, too, for exporters on the Continent. A new business survey yesterday showed further signs of strong growth and falling unemployment in the Eurozone, where even Germany, weakest of the key member economies, is recovering impressively from its earlier recession.

For Euro-11 politicians and central bankers, however, this is a nail-biting episode. The political capital at stake in success or failure of the euro threatens to turn everyday financial volatility into high drama.

With hindsight, the decision to delay the introduction of euro notes and coins until 2002 looks like a mistake. It means that for the citizens of the Euro-11 some of the most tangible benefits of the single currency, in the form of completely transparent prices and greater competition, have been postponed.

What's more, the virtual nature of today's euro, which exists only in banks' computer entries, introduces an additional element of uncertainty by allowing sceptics - and mostly they are found in London - to argue that the single currency could yet be unpicked. The argument is fuelled by the signs that some countries, such as Ireland, need higher interest rates than the level currently imposed by the needs of the big economies such as Germany, still only part-way into its recovery. The costs of the one-size-fits-all policy are plain to see, while the more diffuse microeconomic benefits are slow and hidden.

The steady subterranean reshaping of the European economy is only partly unveiled from time to time by an announcement such as this week's merger of the German and London stock exchanges, which will price companies' shares in euros. Public support for the new currency is unlikely to take root until the structural benefits of lower costs and greater competition become a bit clearer. Even so, there is scant likelihood the sceptics' hope of an early break-up will be fulfilled. The genuine political tensions aroused within Euroland by the weak currency do not remotely amount to the prelude to a divorce.

There is also a good chance that the euro's puzzling fall will turn into an equally extreme and mysterious recovery when the financial markets go into reverse.

The big question is not what will happen to the exchange rate, or even why, but rather when.

Comments