Questions & Answers

Fri, Dec 18, 1998, 00:00

European Monetary Union and the euroFrom January 1st, the Republic will undergo a fundamental change in economic and monetary affairs, more dramatic even than the shift to decimalisation in 1971. This week we take a look at what this new world is and how it is likely to affect individuals.

What is EMU?

The initials EMU stand for Economic and Monetary Union. It is yet another step on the way to a single internal market within the European Union. A key feature of this stage is the introduction of a new currency - the euro. Never before has a single currency been created across an industrialised zone such as the 11 founder members in western Europe.

What effectively will happen is that on December 31st, the rate of each of the 11 founding currencies will be set in relation to each other. These rates will be fixed thereafter and the euro will be born.

Of course, that doesn't mean you will get your hands on any of these euros any time soon. In the three-year transition period up to 2002, we will still use Irish coins and banknotes but these will be merely denominations of the euro; they will not be independent of French francs, German marks and so on. But the notes and coins themselves will only become available on January 1st, 2002. In the meantime, the euro will be used in a growing number of paper transactions, especially in business.

It is a huge experiment but one which has been planned in meticulous detail. No one even wants to contemplate the price of failure to make the euro the acceptable currency for consumers in the EU.

And what will this euro be worth?

The fixed rate between the pound and the euro will not be set until December 31st, but it is likely to be worth around 80 pence. That means £1 will be worth approximately £1.25. Each euro will be divided into 100 cents. When the coins appear, they will be in denominations ranging from one cents to two euros. The banknotes will range from five euros to 500.

So what's in it for the consumer?

In the first place, gone will be the days of exchange rates which increased the uncertainty of cross-border trade. That should lead to greater competition and price transparency. Consumers will be able to see exactly how the price of cars, financial services and even food compares here and in other European states. The increase in competition will help ensure that certain sectors which have enjoyed inflated margins in our island state no longer do so, to the benefit of the consumer. When the coins and banknotes are introduced in 2002, travel within Europe will become simpler with only one currency across all boundaries.

What about the dreaded consumer rip-off we remember from the introduction of decimalisation?

No doubt there will be some degree of chaos with retailers having to use two tills and price their goods in both pounds and euros for a period of up to six months in 2002 until our national notes disappear. However, in this era of greater competition, we can at least hope that retailers will use the changeover to woo customers rather than chase them away. Remember too that many people have grim memories of the decimal rip-off and will be on their guard against any repeat. However, I suppose it is inevitable that, in the process of rounding to the nearest euro, certain companies will seek to build in that little extra margin. The three-year transition period is in place partly to ensure that people are familiar with the new currency by the time it appears on the streets, making such a rip-off less likely.

What is the impact of sterling staying outside the market?

That is one of the great unknowns. In the run-up to EMU, economists here have spent more time arguing not about whether we should accept the concept of a monetary union but whether we should consider entering such a union when our largest trading partner, Britain, was staying out.

The consensus appears to be that Britain will join - possibly even prior to the 2002 deadline for the introduction of euro banknotes and coins. However, in the interim, companies in the Republic could face a stiff challenge if the value of sterling should fall sharply once our rate is fixed along with those of all the other members of EMU. They would find it more difficult to sell their goods in Britain as our prices would be higher relative to those of British competitors; these competitors would also be able to sell goods more cheaply into the Irish market and we will not be able to resort to devaluation to balance the scales. The only option for firms would be to cut costs, which might well impact on jobs, or accept lower profit margins.

What makes this issue even more important for Irish exporters is that sterling is widely considered to be overvalued at present and there are many who forecast a substantial drop for the currency against its European peers.

How will it affect personal financial services?

Financial services companies will feel the wind of change before most of us. From January 1st, they will lose a large chunk of their income through the ending of exchange rates between EMU member-states. The banks will still be able to charge a handling fee for such transactions but they will not be able to capitalise on the deal as they do at present by selling the currency to you at one rate and buying it off you at another. Of course, such transactions will still occur for those seeking sterling, dollars, yen or any other currency outside the EMU.

Technically, people will be able to shop abroad for financial services - mortgages, insurance, pensions, savings and loans - but, at least initially, it is not likely that there will be much business of this nature going on. What is likely to happen is that the banks over here, which have traditionally enjoyed margins of roughly twice those of their European counterparts, will become more competitive and offer rates and terms which will be closer to those available elsewhere in the EMU.

While banks will offer euro accounts, cheque books and credit cards from January, these will take some time to become popular, especially as many retailers will not be geared up to take them initially. What will happen with interest rates? Who will set them once the euro comes in?

Two things are likely to occur in the mortgage market. First, you will find a wider range of mortgage products on offer, including longer-term fixed mortgages.

For people on variable rates, they will already be weighing up the advantages of the move to EMU with the tumbling interest rates in recent months. Come January, the Central Bank will no longer set the benchmark lending rates upon which institutions base their mortgage and other interest rates. These will instead be set by the recently formed European Central Bank. Of course, this new bank will be looking at EMU-wide factors when it comes to setting rates rather than the specific factors affecting any one market, such as the Republic. A taste of what may be to come was evident in recent months as the Central Bank was forced to cut its interest rates to the uniform EMU entry rate at a time when the booming Irish economy and burgeoning credit growth indicated rates should be moving up rather than down. Without the power to control interest rates, the Government of the day will have fewer tools to tackle any local economic crises which do arise; instead it will have to tailor its costs to fit, something all parties have been noticeably poor at doing down the years.

What will happen to people who like to dabble in the stock market or those who have some shares from various recent windfalls?

Investors in the stock market will be confronting euros far sooner than those who don't bother with such things. The stock market will quote all its shares in euros from January 1st, although stockbrokers will still accept payments in pounds. In addition, those who like to keep track of how their portfolios are doing will find that different companies will make the switch to reporting their annual returns in euros at different times. Some, especially some of the larger groups, will make the move straight away in 1999; others, more noticeably the smaller firms on the Stock Exchange, will hold off until nearer the 2002 deadline.

More people than you might think will be affected in this way. Most of us have pensions of some sort and these firms are likely to be dealing in euros and looking further afield to invest their funds in the absence of exchange rates. Furthermore, there are a host of people who now own shares through the demutualisation of Irish Life, Irish Permanent, Norwich Union and First Active. The numbers involved will grown exponentially this year when Telecom Eireann offers customers the chance to buy a stake in the group.

What about at work: is my employer going to be paying me in euros?

Once the euro is formally introduced in January, you will find that some larger companies, especially European multinationals may well switch over their entire accounting systems to euros. However, few employers are likely to try to force employees to accept payment in euros, at least initially. In any case, the banks have said they will translate pounds to euros and vice versa. However, if you are paid in euros, do make sure that you don't lose out in the rounding process.

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