Prodi's Conference Address Set To Spark Euro Debate

FOREX '99

MILAN--With Romano Prodi, president-elect of the European Commission, slated to address delegates at the Forex conference in Milan, the progress of the euro in its first six months of trading and the future of European Economic & Monetary Union (EMU) look set to dominate proceedings.

Prodi was scheduled to lead Friday's business session on "Development of worldwide monetary policies: should we look for further harmonization?" along with Sirkka Hamalainen, of the executive board of the European Central Bank (ECB). However, the official reopening of the European Commission under Prodi's leadership was recently rescheduled for the same day.

Conference organizers are in the process of trying to arrange for Prodi to address conference delegates at a different time during the week.

If the audience goes ahead, it is likely to spark fierce debate on the euro, coming only days after Prodi's talk of Italy's potential exit from EMU due to inflationary pressure. Although Prodi has stated that his remarks were taken out of context, the gaffe drove the euro to record lows of around USD1.318.

This inauspicious start to last week's trading is a far cry from discussions in January and February of a potential tripolar currency system, between the dollar, the Japanese yen and the euro.

Most market officials doubt that a disintegration of the entire EMU project is a real possibility, but the euro is still 12 per cent down from its launch level of USD1.17--a remarkably poor showing given the predictions of some analysts only six or seven months ago.

Euro Euphoria

In the run-up to the launch, many economists were forecasting that the euro would exceed expectations, and quickly rival the dollar as a reserve currency.

Most of the analysts interviewed by FX Week at the end of 1998 anticipated that the euro would strengthen against the dollar in its initial months, as it benefited from a benign economic environment in which European growth outstripped that of the US.

However, far from basking in an inaugural honeymoon, the euro has drifted steadily down, as an unexpected combination of poor European economic news, especially in Germany, and surprisingly buoyant US growth, have weighed heavily on the new currency.

The uncertainty of war in Kosovo and political concerns as left-wing governments have fanned fears of inflationary economic policy, have also conspired to drive the euro down.

The latest buzzword in the FX market has been "dollar parity" and many economists now think that this is inevitable before a recovery is likely.

"If you look at the region as a whole, and the value of a synthetic euro, the currency has been weakening for seven years," says Michael Rosenberg, head of FX research at Deutsche Bank in New York. "I don't think the euro will recover before parity with the US dollar is reached."

But not everyone agrees with this bearish outlook. David Ethridge, director of currency analysis at Standard and Poor's MMS International in New York is more upbeat. "Parity would be an attack on the very notion of EMU," he says. "We are a little less pessimistic than some on that issue, and don't consider it to be very likely."

Ethridge claims that the euro's fall below USD1.05 has been the result of excessively bearish sentiment related to the Kosovo crisis more than the economic fundamentals. He expects that over the next few months, the currency will "slowly grind higher, but every step of the way will be an effort." He forecasts that the euro will rebound to around USD1.07 against the dollar towards the end of the summer.

Recovery

Most of the analysts, including both Rosenberg and Ethridge, agree that that the weakness of the euro is being driven more by the strength of the US economy than poor growth in Europe.

They say a recovery will depend on the strength of a tightening in US interest rates, which has been widely anticipated by the market.

Ethridge adds that another reason why the euro has found it so hard to rally is that so many speculative investors failed to anticipate the fall and are reluctant to bid the currency back up. "Once you've been burned once, you don't go back that easily," he says.

But despite the gloom that has surrounded the euro, most officials agree that the technical introduction of the currency was an overwhelming success. Despite a few minor payment difficulties, none of the system breakdowns that had been anticipated came to fruition.

"That was one area that can't be faulted," says one FX sales dealer at a bank in New York. "The technicians had done their homework and the preparation was done on schedule. There were a few anxious moments in the first few weeks, but none of the disaster scenarios turned out to be true."

Despite its steady decline, many analysts are also guardedly optimistic about the euro's longer-term outlook. Craig Larimer, managing director of Banc One's international market analysis unit, told delegates at a recent briefing hosted by the Chicago Mercantile Exchange that the euro will likely roll back to its introductory price level by the end of this year.

"Markets have always been cyclical and always will be," says the sales dealer. "One of these days, the situation in Germany will turn around, and things may decline in the US, then the euro will strengthen again."

--Robin Pagnamenta

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