Pound likely to enter at DM central rate

As the move towards monetary union gathers pace there is increased speculation about the likely rate at which the pound will join. While the official announcement on the rate - and indeed which countries will join - will not be made until next May there appears to a growing consensus that it is likely to be at our current central rate of DM2.41.

As a result the pound has fallen significantly over recent weeks against the deutschmark and sterling. Mr Jim O'Leary, chief economist at Davy Stockbrokers added his voice this week, when he argued that central rates will be the most likely option.

In Davy's paper on Irish interest rate markets in the run-up to EMU, Mr O'Leary argues that while it is still possible that we will enter at a higher rate, it is not probable. He points to the two opposing arguments. On one hand if the pound were to enter at too low a rate it could pose inflationary consequences for the economy. The problem with entering at too high a rate is that it would affect competitiveness.

As he points out, the exchange rate decision will be taken by the Government and not the Central Bank or the Department of Finance, which are traditionally more cautious about inflation.

The Government, on the other hand, is likely to worry more about the impact of any loss of competitiveness.

This is all the more likely he says, since one of the most politically negative consequences of overheating - higher interest rates - will be absent in monetary union.

According to Mr O'Leary, the Government would probably be willing to accept an exchange rate against sterling of around 95p or even lower considering sterling's long run average value of around DM2.5-DM2.6.

Given, this, Mr O'Leary suggests that a range of DM2.37-2.47 could be considered fair. And, of course, our central parity is within this range.

However, he also points out that the Government may change its attitude to inflationary risk in the months ahead.

So far inflation has been very low, although it will be interesting to see if the slight pick-up in September is carried forward. But it would take a very sharp acceleration to push the inflation rate up into the danger zone of over 3 per cent. One other event which could have an impact would be a decision by the British government to take sterling into the ERM. If this were to happen it would be seen as a first step to entering the single currency and sterling would probably trade down towards its expected average of DM2.5-2.6, leaving the central rate for the pound a very congenial possibility.

Nevertheless, he points out that a significantly higher rate cannot be ruled out. According to Mr O`Leary, because of Ireland's small size, the other EU countries are not overly concerned what rate we enter at.

However, this could all change if Britain announced its intention to join. In that case the decision on the pound's entry rate could have third-party effects that the other countries could find to ignore.

A low entry rate for the pound at the central parity could then provide ammunition for the British government to negotiate a low re-entry rate for sterling.

Other countries, particularly those with a large trade exposure to Britain, could be anxious to avoid giving Britain this sort of ammunition, he says.