Policy minefield set to mar G7 summit

News Analysis: The US is digging in its heels over exchange rates and tension is rising as the Group of Seven prepares to meet in Bonn

WHEN MINISTERS and central bankers from the Group of Seven leading industrial nations meet in Bonn this weekend, there will be one conspicuous, and rather disappointed absentee. Yves-Thibault de Silguy, the EU's monetary affairs commissioner was expecting, under an agreement made by Europe's leaders in December, to represent the 11-nation eurozone. But despite a phone call from Gerhard Schroder, the German Chancellor, to President Bill Clinton, America has refused him a seat, saying that the EU is over- represented.

In the scheme of things it is a small setback for a currency which was launched in January with a sizeable fanfare and to much market acclaim. But it is also a sign of teething troubles, which have taken the gloss from a generally successful debut.

Since the beginning of 1999 the euro has lost roughly 1 per cent of its value a week. This week the European Commission criticised France and Germany, the Continent's two most powerful economies, for lack of ambition in their plans to meet the Stability and Growth Pact to which all euro countries must adhere.

In Brussels the depreciation of the euro has caused little alarm, partly because it helps European exporters. It is viewed, according to one source, as "more a question of the strength of the dollar than the weakness of the euro".

In fact, tensions over economic policy within the Group of Seven could scarcely be higher ahead of tomorrow's meeting.

The German government, like the French and Japanese, has expressed the desire to see managed exchange-rate zones for the G7 currencies. The US has plain dismissed the idea. As Robert Rubin, the Treasury Secretary, noted this week, Euroland can scarcely hope to keep a stable exchange rate against the dollar if it cannot match the US growth performance.

The US delegation will be urging both Japanese and Europeans to take firm steps to boost growth. And while both might agree about the need for faster growth, they differ profoundly about the means.

The biggest difficulty afflicting the euro is the lack of harmony between the European Central Bank (ECB) and the most powerful political voices in the eurozone. After a brief truce, the German Finance Minister, Oskar Lafontaine, has renewed his call for lower interest rates, and for emphasis on growth, investment and job creation - a sentiment backed by his French counterpart, Dominique Strauss-Kahn.

The ECB, its independence enshrined in treaty, sticks firmly to its mandate of achieving price stability, taking the view that structural reform of the European economies is the key to job creation. After all, they point out, if low interest rates are decisive, why is the Japanese economy not booming?

There is no point boosting demand until politicians introduce reforms that will move the inflationary buffers further back, the bankers argue.

The debate is far from over and is having its own effect on the markets, which may have marked the euro down partly in anticipation of the lower rates Mr Lafontaine wants.

As one European diplomat put it yesterday: "We have to decide how to develop the policy mix and there is a power struggle going on between the institutions."

In typically robust mood Mr Lafontaine took his argument to the European Parliament yesterday, saying that successful economies are not always based on balanced budgets. Look, he told MEPs, at Ronald Reagan's economic policy: "He ran up enormous debts ... combined with massive tax cuts. I don't think the [European] Commission would have let Reagan loose on the streets".

Mr Lafontaine, it is true, joked on his way in to the ECB's tower in Frankfurt that they would not cut rates yesterday precisely because of his presence. But he does not yet appear to have realised that every time he threatens the ECB the euro bond markets fall.

As for Japan, there is no question that all the G7 partners want to see the depressed economy start to recover, but it is an economic problem with no obvious solution.

Last week brought interest rate cuts by the Bank of Japan, and this week a decision that the Trust Fund Bureau, which manages postal savings, would help trim long-term interest rates by resuming purchases of government bonds. But neither move is thought adequate.

The Japanese government has accepted that a weaker yen is the only remaining option, having originally been reluctant to see it depreciate because of the damage this will cause already weak bank and corporate balance sheets.

The markets will therefore be watching the weekend's communique for a hint that a weak yen will be acceptable to the US too. For it is facing a record trade deficit. Even if Mr Rubin is happy to see the dollar rise for the sake of the world, he might not be able to signal this for fear of the reaction of US exporters.

All in all, the financial markets have scant hopes of the weekend meeting. "If there is no agreement, there is no action," said Stephen Hannah of IBJ in London.