Stability of currencies guaranteed

THE stability of currencies in the EU once the euro has been launched will be assured by a new exchange rate mechanism based substantially on the current one but with significant differences.

These address perceived current weaknesses and the need to reflect a new asymmetry between members once the euro, the "anchor" of the system, is launched.

The outline of the new mechanism was presented to ministers - and then substantially endorsed by them - by the president of the European Monetary Institute, Mr Alexndre Lamfalussy.

It would be based, he said, on the principle, already in the treaty, that monetary policy is a matter "of common interest" and be established "to provide a framework for counteracting market pressures that are not warranted in the light of the underlying fundamentals".

The idea is that overall monetary stability will be provided by convergence of the economies involved, but that a means must be found to defend fundamentally sound currencies thrown out of kilter by the vagaries of the market.

Currencies would be entitled to join the ERM2 as long as their member states' convergence programmes were sufficiently advanced to manifest "lasting convergence". Once in they would be able to fluctuate between wide bands, probably 15 per cent, either side of the euro.

Co ordinated intervention by national central banks and by the European Central Bank (ECB) would be triggered automatically as a currency approached the margins of the band.

But the system being proposed is also likely to allow those closest to joining the euro to develop an even closer relationship with the ECB. They are likely to be encouraged to reach separate individual agreements with the ECB pegging them to a tighter band or bands, allowing for as little as 2 to 3 per cent fluctuation.

This variable geometry for the ERM2 is reinforced by agreement to give the ECB the right to initiate discussion about possible realignments if it believes that a rate is not sustainable. The bank would also have a say on the rate at which currencies join the mechanism.

Both the latter proposals significantly change current arrangements by removing some of the onus for politically difficult decisions from member states. This rationale still leaves the actual decisions on realignment with member states in the EU's monetary committee.

The German minister for finance, Mr Theo Waigel, argued that it was a "myth" to suggest that Britain's bitter experience with the current ERM was the result of fundamental flaws in the system. Britain, he said, had entered at an unsustainable rate and had exposed some flaws in the system which were now being addressed.

Mr Lamfalussy's report concluded with the observation that a majority of members believed that membership of such a new mechanism should be mandatory for those who qualify. But there is no reason, a priori, why it should not work without one or two recalcitrant member states.