The historic decision adopted at the weekend EU Summit to launch the euro in January 1999 with an initial 11 founding members fundamentally changes the European economic and financial landscape.
The decision to fix exchange rate parties at their current central ERM rates effectively removes exchange rate risk amongst the 11 founding currencies.
While it will take some time for the euro to become fully established, it will create a currency which in time could become as important as the US dollar. Undoubtedly the emergence of a common currency across most of Europe will have far-reaching implications for business throughout the continent.
For Irish investors the new eurozone creates a situation whereby the domestic currency now becomes the euro and therefore the domestic market effectively becomes the combined market of the 11 founding countries. Of course in practice cultural and accounting differences across countries will remain and it is unlikely that an Irish investor will view an investment in the Portuguese market in the same light as he or she would view investment in the Irish market.
Clearly, trying to follow shares in 11 stock markets would be very difficult for even the most dedicated private investor. However, the increased investment opportunities available should not be ignored. Table 1 shows the performance of the Irish stock market and that of the five larger Eurocurrency markets over the past 12 months.
It may come as a surprise to many to see just how strongly some of these European equity markets have performed over the past year. The Italian market has doubled, while Spain has come very close to doubling. The Irish market has been no slouch either, rising by more than 70 per cent in the past 12 months. Interestingly, it has been the markets at the periphery of Europe which have done better.
Countries such as Ireland, Spain and Italy have typically had interest rates at far higher levels than countries at the core of Europe such as Germany, France and the Netherlands. As confidence grew that the euro project would indeed be successful, interest rates in the peripheral countries began to decline towards those of Germany and France.
Declining interest rates have been a major factor in pushing up European equity values. Furthermore, this benign interest rate environment has acted to stimulate economic activity. In some countries such as Spain and, more notably, Ireland the risk of economic overheating is now very real.
Despite the risks of overheating in some countries the new eurozone seems set to enjoy a prolonged period of moderate growth, low inflation and low interest rates. This is an environment which should be very supportive of equity markets.
For many Irish private investors, any overseas investment has tended to be in the British stock market reflecting the close ties between the two countries. More recently investors will have begun to also invest in the US market. Clearly, investment in these markets involves significant currency risks. In contrast, investment in Europe now involves no currency risks and once the euro begins life in 1999, shares in all 11 members will be quoted and settled in euros.
Over time, Irish investors will undoubtedly widen their investment horizons and certainly many of the larger European companies will become as familiar as CRH, Smurfit and Bank of Ireland. From January 1st, 1999, Irish investors will be part of a currency zone that matches the size of the US. This is highlighted in Table 2 where the 11 EMU members combined have a population greater than that of the US.
Assuming all EU members eventually join, the euro will result in a currency and economic area that is significantly larger than the US.
It will only be a matter of time before investors increasingly make their decisions on a Europe-wide rather than on a country-by-country basis.
