A "Real Currency," with Real Impact

Now that the euro is exchanging hands, it'll likely gain against the U.S. dollar and help Europe recover in 2002

So much for the euro haters and doomsayers. Those crisp, new Euro notes and shiny, new coins seem to be as much a hit in the foreign-exchange markets as they are in European banks and stores. The Continential currency has spiked against the almighty U.S. dollar since the glitch-free launch on New Years Day, up more than a cent to trade at around 90.39 cents. What's more, the European Central Bank's decision to hold interest rates steady at 3.25%, which had been expected, did nothing to damage the pro-euro sentiment.

"There's a wave of enthusiasm for the euro," said Belgian Central Bank Governor Guy Quaden on Jan. 3. "The success of its launch has driven home the fact that the currency has a great future."

What's next? Many currency strategists now believe the coming 12 months could see more strengthening for the euro, as it recovers ground lost since its launch as an electronic, accounting currency on Jan. 1, 1999. Measured on a trade-weighted basis, the euro has declined every year of its existence -- by 12% during 1999, 1% during 2000, and 2% in 2001.


  Economists at Credit Suisse First Boston in London now predict the single currency will rise by 10% this year. "The euro could be poised for a new start," says economist Christel Aranda-Hassel. "You can now hold the euro in your hands, you know it is a real currency with intrinsic value," adds one Frankfurt-based currency trader. "The successful introduction of the notes and coins is of immense psychological importance and could change people's attitudes towards the currency."

Ashraf Laidi, chief currency analyst at New York-based MG Financial Group, believes that some major central banks may decide to keep a larger part of their reserves in euros now that it exists as cold, hard cash. The People's Bank of China, the Bank of Japan, the Central Bank of Taiwan, and the Bank of England have all hinted that they may now stock up on the single currency. "The euro is more attractive now than it was when it was just a virtual currency," says a Taiwanese monetary official. "I wouldn't be surprised to see central banks buying it."

Of course, the euro's performance will ultimately rise or fall on the underlying strength of the euro-zone economy. And over the past three years, the U.S. has been a better place to invest because its economy has performed better. Capital even flowed into the U.S. from Europe last year because most investors thought the American economy would recover from recession more strongly than Europe's. As a result, the dollar continued to strengthen against the euro -- even though Europe did not slow as quickly as the U.S.


  There may be optimism on that front as well, however. Forecasters say the euro's arrival has been accompanied by a range of positive developments in the European economy that should help boost the currency's value over both the medium and long terms. Aranda-Hassel notes that the euro zone's "basic balance" -- that is, the sum of its current-account balance plus long-term capital flow -- is growing: "[This] indicates that during the course of 2002, the euro might at last have the opportunity to appreciate."

Other factors are also likely to be supportive: weaker oil prices, tumbling inflation rates, and an expected increase in the acquisition of euro-zone companies by foreign institutions. Economists hope the physical euro's arrival will encourage European governments to make much-needed structural reforms that would make the euro zone more attractive to investors.

In the meantime, the European economic slowdown seems to have run its course. Having grown by just 0.1% in each of the last two quarters, the euro zone is expected to start growing again in the first quarter of 2002. "A recovery will begin in the next six months," predicts Wim Duisenberg, president of the European Central Bank.


  Signs are mounting that a rebound is on the way. German business confidence rose for the first time in four months in November, according to the IFO institute's survey of 7,000 companies. In December, confidence among French manufacturers increased for the first time in 19 months. French car and light-truck sales rose 5.6% in December from a year ago, according to figures published on Jan. 2. Sales for the full year were the best since 1990.

Put it all together, and the euro's launch may turn out to be a significant boost for the Continent this year.

By David Fairlamb in Frankfurt

Edited by Douglas Harbrecht

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