Dismay over euro fudge

Compromise on bank president could damage single currency, say experts

THERE WAS widespread disappointment among financial commentators yesterday with the last minute compromise solution thrashed out in Brussels over the weekend for the position of president of the new European Central Bank.

"Other than no solution at all, this is about the worst possible outcome for financial markets," said Cesar Molinas, joint head of economic and fixed income research at Merrill Lynch Europe.

"Although this split role solution is not unexpected, the fact that the outcome was the result of political horse trading and satisfying national pride is bound to damage the credibility of the bank, its interest rate policy and the new currency," he said.

However, most pundits agreed that reaction today in capital markets was likely to be relatively subdued. Some markets in the City will be open for business, despite the Bank Holiday weekend, so as to respond to the news, while virtually all Continental and US markets are open.

Technically, Wim Duisenberg has been appointed as president for a full eight-year term, but it has been agreed that the 63-year-old former Dutch central banker will voluntarily retire midway through that period to be replaced by a French nominee, likely to be Jean-Claude Trichet, governor of the Bank of France.

Analysts said European bonds and the German mark might pare recent gains after the row. Mr Molinas thought UK gilts and sterling would strengthen, since this was the usual reaction to any setback in the fortunes of the single currency.

Nick Crosby, senior consultant at Price Waterhouse on Emu, said; "French pride has undoubtedly undermined the credibility of the project to some degree, but that doesn't mean it's not going to happen or won't work. Emu has been beset by crisis and impasse right the way through. Even so, it has remained on stream and my advice to companies is get on and prepare for it, because it is going to happen".

The weekend's compromise involves virtually all players in considerably loss of face. Mr Duisenberg is on record as saying he would refuse to do the job unless appointed for the full eight years. Only last week, Hans Tietmeyer, head of the German Bundesbank, warned strongly against fudging the decision.

Mr Molinas said; "It really didn't matter which central banker they gave the job to since they are all hardliners on monetary policy and use much the same methodology. The important thing was not to compromise the terms of the treaty, and that's just what they have done."

Joining Mr Duisenberg on the executive board of the ECB will be Otmar Issing, chief economist at the Bundesbank, Tommaso Padoa-Schioppa, head of the Italian stock market regulator, Eugenio Domingo Solans, Bank of Spain board member, Sirkka Hamalainen, Governor of the Bank of Finland, and Christian Noyer, former chief of staff to France's finance minister.

Peter Praet, chief economist at Generale Bank, said the ECB deal could lead markets to conclude the board would have a tightening bias, but noted it comprised only six of the 17 seats on the ECB "governing council", which is responsible for interest rate decisions. The other 11 seats on the council are held by national central bank governors.

"The agreement is precisely the one talked about last week on which the Bundesbank held a meeting and came out with a strongly worded statement," Padhraic Garvey of ABN-Amro in Amsterdam said. "The market will expect the Bundesbank to do something. They can either talk, or they may feel obliged to act."

The coming week threatens to be turbulent for the new nominees, who on Thursday and Friday face European Parliament members in an open question and answer session about their views on economics and monetary policy.

Parliamentarians have already said that Mr Duisenberg will be questioned about his plans to step down and have threatened to criticise his candidacy.

The 626-seat assembly has the right to give a non-binding opinion on the appointments before leaders rubber stamp them. It will do so in a vote on 13 May.

The compromise, designed to placate France, will fuel investor concern that the ECB will be subject to too much political influence, undermining its determination to keep inflation low.

That could push up yields on European bonds against US Treasuries, and reverse the mark's 4 per cent gain against the dollar in the past month.

"It will be worrying to the markets that there has already been this much political influence over the ECB,'' said Phyllis Reed, a European bond strategist at Barclays Capital. "I would expect to see flows into the US and the UK.''

The mark rose to 1.7808 against the dollar at the close of trading on Friday from about 1.85 on April 3, gains that could also be at risk when European trading resumes today.

The 11 countries named for the start of the single currency on 1 January 1999 - Germany, France, Belgium, the Netherlands, Luxembourg, Austria, Finland, Ireland, Italy, Spain and Portugal - were expected.

Conversion rates for the currency are to be based on exchange-rate targets already in force, ending speculation that any of the 11 currencies will be revalued or devalued. That decision should underpin European currencies, some analysts and investors said.

The agreement rules out changes in conversion rates before the euro is introduced. Some investors had expected that option would be left open, since strong economies, especially Ireland's, may make existing rates incompatible.

To ensure that market exchange rates match the targets by the end of the year, central banks will use "appropriate market techniques,'' the EC statement said. That means if a currency moves away from its target rate, the central banks of the 11 founding members will buy or sell currency to drive rates back into line.

The outcome brought wide condemnation in Germany yesterday despite attempts by Chancellor Helmut Kohl to defend the deal. Business leaders, the media and opposition politicians said public mistrust of currency union could now reach new heights.