Interest rates set to hold until May

Irish short-term interest rates are unlikely to fall before May 1998, according to the latest forecasts from Davy Stockbrokers. May, of course, is the date when EU governments will announce which countries are joining the single currency and at what rates. While the likelihood of monetary union going ahead on time is increasing all the time, Mr Jim O'Leary, chief economist at Davy, pointed out that the Central Bank is still likely to take a cautious approach.

He added that the bank is likely to spread out the necessary reductions in Irish interest rates, to bring them down in line with those in Germany, over the May to December period of next year.

As a result, Davy is forecasting a half-point interest rate cut in May, another half in September and the balance when the single currency actually goes ahead.

According to Mr O'Leary, the other two options - leaving rate cuts to the last possible minute or an immediate cut as soon as the entrants are announced - could both prove too disruptive.

On balance Davy believes that we are also likely to enter the new currency at the current central parity of DM2.41. He pointed out that two issues are highlighted by the decisions, the possibility of overheating if we go in at too low a level or the possibility of losing competitiveness if the entry rate is too high.

This decision would be made much easier if it was known if sterling would be joining the system and at what rate. However, as this is not known and the decision will rest in the hands of the politicians rather than the Department of Finance or the Central Bank, he believes that competitiveness will prove the main worry.

In addition, our recent excellent inflation performance has probably left the authorities reasonably sanguine about future inflationary prospects, he said.

Indeed, Davy has recently significantly revised down its own inflation expectations for next year. It now only expects consumer prices to accelerate to between 2 to 2.5 per cent early next year.

One possible scenario which could undermine this thesis would be a decision from the British government to re-enter the ERM with a view to later joining the single currency.

In such a situation, according to Mr O'Leary, the other EU governments may no longer be so sanguine about our entry level. A low entry level for the pound would provide ammunition for the British to negotiate a low entry level themselves. "The other EU countries would be unlikely to want to present the British with this sort of ammunition."