Continental shifts put the euro plan on shaky ground

THE single currency project is facing a new period of uncertainty. Recent events in Germany and France have again raised questions about whether it can proceed on schedule.

Some now say the project may be postponed, while others believe monetary union could proceed on schedule - but with a large membership.

Either way, it appears the markets have not factored in the possibility that the project may unwind or be delayed. So a period of considerable volatility in European bond and currency markets may be in prospect.

The spur for the latest bout of "euronerves" is the conflict which has broken out between the Bundesbank and the German government. The German central bank's extremely strongly worded opposition to the government's plan to revalue its gold reserves came as a complete surprise.

Chancellor Helmut Kohl last week announced a plan to revalue Germany's gold reserves, in a clear effort to reduce government borrowing to within the levels shown in the Maastricht Treaty.

While few observers would have expected the Bundesbank to be pleased with the plan, the toughness of its response surprised many. The Bundesbank warned that the government's plan was not in line with the rules for a European central bank. According to the bank, it is a "clear interference with Bundesbank independence" and would be in conflict with the Maastricht concept of central bank independence.

In addition, it warned that the decision to revalue the reserves meant that the rules would probably have to be stretched, to allow other states to join.

One interpretation of this is that, if German qualification is on the back of a forced revaluation of the gold, then the Bundesbank might give a negative opinion to any German constitutional court challenge to the project.

So far the politicians insist they will be going ahead with the revaluation. But the mood of German public opinion will not be crucial to the plan's outcome.

On top of this, the surprise victory of the French left wing in the elections last week, and the possibility of another victory on Sunday, casts further uncertainty on the whole project.

Before the French election was called, most analysts believed that the chance of the left coming to power was unlikely. Even French trade union leaders freely admitted they believed it was not on the cards. The conventional wisdom has been that a left wing victory could undermine monetary union.

While the socialists are in favour of the single currency, in theory, they are seen as much less willing to continue with the austerity measures which are needed to get the deficit down. Throw in the possible coalition with the communists, who are against the entire project, and the ground begins to look a lot shakier.

Even if the centre right emerges victorious, the election has cast doubts on the French attitude to EMU. After the resignation of the prime minister, Mr Alain Juppe, there is a possibility that a centreright victory could bring Mr Philippe Seguin to power.

He is the former leader of the anti Maastricht campaign in France. While he has since toned down his opposition, he still describes the measures needed to drive the deficit down as masochistic.

The most optimistic interpretation appears to be that the single currency will go ahead on time and be a broadbased union including the so called "Club Med" countries of Spain, Portugal and Italy.

Many in the French left may well be pleased with this. They are almost unanimously in favour of bringing the Italians into the project. One of the main reasons, of course, is the fear of what could happen to French jobs if the Italians, on the outside, attempted a competitive devaluation.

However, a broad EMU is also expected to be weaker than a narrow one, which would be more fully dominated by Germany. And whether the Germans are willing to allow Italy to join remains to be seen.

There is an argument that the new European Central Bank, faced with the prospect of a weak euro, may feel compelled to raise interest rates to show its monetary credentials. If this is the case then Irish rate expectation may have to be revised upward.

And indeed, if the project is either postponed or cancelled, Irish interest rates will almost certainly be heading upwards sooner than many expected.