CURRENCIES : Weakened euro could fuel stronger growth

A weak euro may be just what Europe needs, City analysts are now muttering.

Recent events in Germany and France have spurred speculation that the criteria for entry into European monetary union will be relaxed, leading to a bigger group of starting participants and a weaker single currency than expected.

While that has prompted some hand-wringing among bond and currency traders, for the most part Europe's financial markets have not been too fussed.

Part of the reason may be that a weaker euro might not be such bad news, especially for the sluggish economies of France and Germany.

"Given the events of the last few days, we believe a broader EMU is more likely," said David Ballance, manager at Threadneedle Investment Managers. "That means the euro will be weaker than would otherwise have been the case - and that should be friendlier toward European growth."

After all, a strong currency has its own pitfalls. The Bank of France's "franc fort" policy kept the currency relatively stable and inflation low, yet the French economy remains in the doldrums, with unemployment at 12.8 per cent.

With about 3.1 million French citizens out of work, a Socialist-led coalition won parliamentary elections last weekend by pledging to create 700,000 jobs. The Socialists argued for a looser interpretation of the EMU criteria, including the limits on public debt and deficits.

Germany, with Europe's strongest and most stable postwar currency, is only now showing signs of emerging from several years of moribund growth. Unemployment stands at 11.1 per cent. The government reported yesterday that the economy grew 0.4 per cent in the first quarter and manufacturing orders jumped in April.

"Exports are flourishing - they are driving the economy," said Jorg Sihler, manager at Deutsche Gesellschaft fur Fondsverwaltung.

The German currency has fallen 22 per cent against the dollar since March 1995, when it reached a postwar high, and has fallen against other currencies.

However, there are some dangers from a weaker euro. It could lead to faster inflation and higher interest rates, which could in turn prove a drag on growth over the longer term.

A willingness to loosen EMU criteria implies that members "will be prepared to see more government debt issued, which I think would not be in Europe's interest," said Andrew Buxton, Barclays Bank chairman.

Still, the benefits of euro weakness could outweigh the costs. "There is the risk that a weaker euro will raise the spectre of higher interest rates and higher inflation," said Mr Ballance. "But with most of Europe converging at 12 per cent unemployment, that isn't a threat."

If the pain of fiscal belt-tightening eases in the months ahead, as EMU hopefuls relax about the cost of joining the club, this could lead to a faster recovery.

"The political commitment is still there and that, combined with the Socialist victory In France, point to a soft euro," said Brian Martin, the chief currency economist at BZW. "A soft euro is positive in terms of growth." Copyright: IOS & Bloomberg