Bank chief warns on interest rates

THE Governor of the Central Bank has warned that interest rates may not fall substantially after monetary union.

While the Government parties continue to insist that the single currency will go ahead on January 1st, 1999, Mr Maurice O'Connell also warned that it "cannot be entirely sure for some time ahead".

Mr O'Connell, speaking at the annual IBEC business conference, said upcoming political events or severe economic disappointments might yet upset arrangements. He added, however, that it would take something "quite out of the ordinary" to derail the process at this stage.

According to Mr Jim O'Leary, chief economist at Davy Stockbrokers, the speech may have less to do with what the bank thinks about monetary union, than it does about why it has remained so vigilant on monetary policy.

"Part of the reason for the bank's obvious reluctance to lower rates recently, and for the recent increase, is that it is mindful of the risks that Ireland may not be on board for whatever reason," Mr O'Leary said.

"If the bank was absolutely sure we were going to be there, it would not make any sense whatsoever to raise rates. They would already be a good deal lower."

Echoing warnings from other European central banks, Mr O'Conell said that politicians should not be allowed to dilute the entry standards for the single currency.

He admitted that the political authorities will exercise reasonable flexibility but said their room for manoeuvre should be restricted.

"They cannot afford to dilute standards to a point where EMU might lose credibility," he said.

In a warning that interest rates in other Europe countries may rise, Mr O'Connell stressed that because the new European Central Bank will have no track record it will have to [gain credibility immediately.

"The early days may be rather uneasy," he warned. It would probably follow a disciplined (even austere) line to establish its credentials on inflation and provide the right background for the euro.

Mr O'Connell warned that Irish interest rates may not fall after entering the single currency. "It would be a mistake to conclude that Irish rates must automatically move downwards, substantially.

"One should not rule out the possibility that European rates, which are at unusually low levels, might well move upwards in the meantime."

According to Mr O'Leary the Governor may have been trying to deflate optimistic expectations on interest rates.

The message could be, "do not borrow today on the assumption that EMU is going to be there for definite", Mr O'Leary said.

According to the Governor it is also a "serious concern" that public support has not been mobilised across much of Europe. "Insufficient political energy has been devoted to reassuring people of the political and economic merits of a single currency.

Despite the reservation, Mr O'Connell said it still seems "highly likely" that we will participate from January 1st, 1999. On the debate about whether to participate without Britain, Mr O'Connell said the problems would not be nearly so dramatic as sometimes presented.

He said it would be in Britain's interest to avoid wild currency swings and the debate on sterling had distracted from a proper assessment of other important considerations.

"We may have good reason to worry about greater centralisation with a single currency," he said. "It is distinctly possible that larger financial centres, such as Frankfurt, London or Paris may gain competitive advantage because of economies of scale.

"For the future, the best response to loss of competitiveness to cut costs and improve productivity."

He warned that EMU would not provide any ready made answers. "It will not rectify structural difficulties."