Euro continues to strengthen as dollar sales rise on fears of war

The euro has continued to strengthen as nervous investors sell the dollar ahead of any military strike on Iraq.

The European currency was again trading at $1.02, an increase of almost 15 per cent this year. European Central Bank (ECB) governing council member Mr Ernst Welteke has welcomed its appreciation in value on the international currency markets. He said it would help to tame price pressures across Europe.

"Achieving our price perspective will be made easier," Mr Welteke, who is also the Bundesbank president, said yesterday.

The euro has been trading above $1.02 over the past few days. The ECB will be hoping that its surge can be sustained and will help to dampen inflationary pressures and meet its 2 per cent target.

Some analysts have suggested loosening the ECB's 2 per cent inflation ceiling, especially when it is considering admitting new members. While the Bank is reviewing its inflation policies, Mr Welteke said it would be problematic to question the target. "I am not convinced ECB monetary strategy needs change."

As for the timetable to admit 10 new countries, mostly from Eastern Europe, into the euro zone, Mr Welteke said some might be ready by 2007 but they should not rush.

Some economists believe the euro's rise will be a short-term feature and is more of a reaction to concerns about the dollar's prospects rather than confidence about strengthening economic growth in Europe. Dr Dan McLaughlin, Bank of Ireland's chief economist, said the latest surge was primarily due to a shift away from holding dollars in case the situation heightens in the Middle East. "It is not based on the euro's fundamentals. US economic data have been more impressive, showing that economy is growing more rapidly than Europe," he said.

Mr Welteke signalled further scope for cuts in European interest rates. Yesterday he said Europe still had room for manoeuvre on interest rates and that price pressures should not prove a constraint on monetary policy.

"Real estate prices are relatively stable, share market losses are not as large in Germany as comparable economies, and European monetary policy still has leeway."

But he declined to comment on whether the ECB is currently leaning towards cutting its benchmark interest rates, now at 2.75 per cent after a 0.50 percentage point reduction on December 5th.

However, he is not alone in opening the door to adjusting interest rates in the months ahead. ECB president Mr Wim Duisenberg said at the weekend that the Bank might need to fire off its monetary weapons if there was a protracted war with Iraq.

A drawn-out war is widely viewed as a significant risk to the European growth outlook. It could push oil prices up sharply and damage already-fragile business and consumer confidence, sending the weakened European economy into recession. Mr Welteke also said the economy was far from a deflation situation, where prices were in general decline.

- (Additional reporting by Reuters)