Markets see row as evidence of lack of euro coherence

ANALYSIS: the Republic's endorsement of the Nice Treaty is unlikely tohave any long-term impact on the euro as membership is a long wayoff for applicant states, writes Oliver Mangan

Ireland's endorsement of the Nice Treaty in the weekend referendum has had little enough impact on the foreign exchange markets. Opinion polls had indicated that a Yes vote was likely so markets had largely discounted the result. The Irish Yes vote is seen as helping to keep enlargement of the EU on track for 2004.

However, membership of the euro is still a considerable distance off for the 10 applicant states. This is not expected to occur until 2006 at the earliest.

Hence, the Irish vote is unlikely to have any long-term impact on the euro.

Indeed, the market is paying much more attention to the ongoing row about the EU's Stability and Growth Pact. The pact was designed to help underpin the euro by providing a set of budgetary rules that are to be adhered to by the member countries of the single currency.

However, the EU Commission president, Mr Romano Prodi, described these rules as "stupid" last week.

His comments stunned the markets and have attracted widespread criticism.

European Central Bank council member and Bundesbank president Mr Ernst Welteke warned that "calling the pact into question is very dangerous because it could undermine confidence in the euro".

The row is seen by the markets as further evidence of a lack of coherence at the heart of policy formation in the euro zone.

It also further highlights the lack of attractive alternatives to the US dollar at the present time. Both the euro zone and Japan continue to underperform the US economy, despite the woes that have beset the American economy during the past couple of years.

The US authorities have aggressively eased fiscal and monetary policy to reignite their economy. Meanwhile, conventional economic policies haven't worked in Japan, which remains mired close to recession.

Meanwhile, policy paralysis, among other factors, has resulted in well-below-trend growth in the euro zone in recent years.

Therefore, although the US currency remains weighed down by a large current account deficit on the balance of payments, amounting to close to 5 per cent of GDP, it has shown a remarkable degree of resilience in recent months.

Indeed, it has recovered from a mid-year low of $1.02 against the euro to trade in a $0.96-0.99 range in recent months. The dollar has also rallied against the yen since mid-year.

Both balance of payments data and asset allocation surveys of fund managers show a continuing strong appetite for US dollar-denominated paper.

Inflows from abroad into US government bonds have risen very sharply this year, underlining their safe-haven status at a time of great uncertainty.

Furthermore, despite the wild gyrations of stock markets, overseas buying of US equities has continued.

Indeed, it is worth noting that the falls in leading European stock markets have been more severe than in key US equity market indices, despite impressions to the contrary.

It is also worth pointing out that, compared to the wild swings on equity and bond markets, the forex markets have been relatively becalmed in recent months.

For now, there seems little to suggest that the dollar/euro rate will break out of a $0.95-1.00 range anytime soon.

Uncertainty regarding the outlook for the world economy, ongoing global geopolitical tensions and continuing volatility on equity markets are likely to keep currency movements within relatively tight ranges in the coming months.

On a longer-term view, should the US economy return to a stable, relatively strong growth path and equity markets begin to recover, the dollar is then likely to become the favoured currency on forex markets once again.

Oliver Mangan is chief bond economist with AIB Global Treasury