Alarm at easing of limits on euro

COUNTRIES launching big investment projects may be allowed to breach tough limits laid down for the single currency, the European Commission said, yesterday, in a move which set alarm bells ringing in the City and in Central banks across Europe.

The intervention, which follows a new Keynesian push for growth made clear by centre-left European leaders at their summit meeting in Austria over the weekend, threatens to re-open the debate about whether politicians or central bankers are in the driving seat of the euro.

Some City analysts saw it as evidence of a shift away from the economic rigours built into the euro's launch, at the insistence of Germany's former finance minister, Theo Waigel. Eleven of the 15 European Union governments are now run by left or centre-left parties.

The Bundesbank's vice-president, Juergen Stark, defended the existing independence of the European Central Bank and said "calls to ease the reins" to boost employment are "neither helpful nor appropriate".

Amid mounting speculation about the direction of European economic policy, the Commission conceded yesterday that spending on investment would be looked on more favourably than current spending. A spokesman said the Commission "favours public investment over current spending", adding: "In assessing a mounting budget deficit, the Commission will take into account the relative size of public investment contributions to that figure compared to the size of current spending."

Under the pact countries that spend more than 3 per cent of their gross domestic product can be fined. Asked whether a government which breached it because of its investment programme would face penalties, he replied that he was "not in a position to anticipate" or "prejudge" the outcome.

The provision for flexibility was written into the pact but was rarely stressed before Germany's recent political shift to the left and the background of rising tension between the Bundesbank and Germany's new, more left- wing finance minister, Oskar Lafontaine. Over the weekend he challenged the bank's long-held assumptions by arguing that monetary policy should be used to boost growth and employment, not just to control inflation.

Jane Foley, currency strategist at Barclays Capital, said: "The fear of rising budget deficits would ultimately undermine the euro, so the markets are keen to see how central bankers respond to the challenges from politicians."

She added: "The more convinced the market becomes that politics could win the upper hand, the softer the euro will start."

David Coleman, chief economist at CIBC Woody Gundy World Markets, added: "It looks like the stability pact will be consigned to the dustbin of history."