Vital to get pound's entry rate at favourable level

The possibility of a revaluation of the pound's central rate in the ERM is becoming more distant. The Central Bank is still worried about the re-emergence of inflation, given the decline in the trade-weighted exchange rate index - the pound's average value on the market. However, the political reality is that a revaluation will be difficult to order and it is thus looking more likely that the pound will join monetary union at its current DM2.41 central rate.

The Minister for Finance, Mr McCreevy, will be coming under pressure from his own civil servants, as well as from officials at the Central Bank, to sanction such a revaluation. With central ERM rates set to be used as the rates at which currencies enter monetary union, a revaluation would allow the pound to join above its current DM2.41 central rate, although it is still likely to join at below its current DM2.57 trading level.

Mr McCreevy is likely to base any decision on whether there will be a revaluation on the behaviour of sterling over the first few months of 1998. Thus, suggestions that a "deal" has already been done with our EU partners appear to be premature.

Both Dame Street and Merrion Street will be arguing about the dangers of inflation given that so far this year the trade-weighted index has fallen by almost 7 per cent since the high point of 70.41 at the end of last year. However, taking the 68.47 average of last year and the likely average this year of around 66, the index has really only fallen by 3.6 per cent.

This fall has not yet fed through to inflation although the Bank would argue that the once-off competitiveness factors which inhibited inflation this year will not carry over for a similar golden scenario next year, if the tradeweighted index were to fall again.

The Bank will argue that a further fall in the pound's value to its current central ERM rate would certainly have an impact on inflation.

In making its views known, the Bank will base its case on its own calculation of the effective (or average) exchange rate of the pound. Arguments that the Central Bank index which is kept very secret in terms of its make-up is unrepresentative and ignores massive declines in many Asian currencies are also dismissed.

A detailed look at the make up of imports from countries such as Singapore, Malaysia and South Korea, reveals that much of them are intra-industry if not intra-company trade and as a result merely add to the profit margins of the multi-nationals.

One of the main points against arguments for a revaluation, according to Dr Dan McLaughlin, chief economist at Riada, is that the deutschmark is trading below its own central ERM rate.

Thus while we are currently trading 6 per cent above the mark we are only about 4 per cent above our central rate against the ecu the key rate which would be used to determine any revaluation.

The pound is trading at around 1.3 ecus only slightly above its central rate of 1.25 ecus. However, the Central Bank and the Department of Finance may quibble with the argument. After all the ecu includes such currencies as sterling, the Greek drachma and the Danish krone which will not be entering monetary union. And the announcement next May will set bilateral conversion rates rates for the pound against all the other currencies joining monetary union the most important of which is the mark rate.

If a revaluation was to be ordered there is much debate over the likely date of the announcement. Those who believe a revaluation is one the cards argue that such a move would have to be out of the way before the Central Bank could sanction any rate cuts.

Thus with the European Monetary Institute and Commission due to complete their reports of the respective economies in March they argue that a revaluation of the pound's central ERM rate is likely as early as Febuary further away than February.

While this does make sense, the Minister is likely to be reluctant to order a revaluation before it is clear whether sterling is in long-term decline.

In the past week, sterling lost almost 10 pfennigs, highlighting its volatility which could be so damaging to Irish competitiveness. However, by the end of the week, profit taking had set up and the currency was once again on the rise.

The pragmatic view which is thought to please some of the Minister's political advisers is that if there is a competitive gain there to be had, it is better to take advantage than to ignore it. And Ireland is perhaps the only state to join the single currency which is in the position to take such an advantage. Few observers doubt that other countries would do the same if they got the opportunity.

The risk is higher inflation. While it seems likely there will be some pick-up as both the OECD and Morgan Stanley warned this week overall any rises should be held in check by modest wage rises.

There are other compelling political reasons for avoiding revaluation. Farmers are screaming about falling beef prices and a devaluation of the green pound to ensure extra funds from the EU would do much to boost their morale. The exporters are also likely to scream hard if a revaluation were ordered.

All in all, the Government may choose against a revaluation of the pound's central rate, in a bid to get a last competitive boost as we enter monetary union. They will never get another chance.