Finance ministers voice concerns about euro

By Tony Barber in Brussels

Published: March 4 2008 11:19 | Last updated: March 4 2008 11:19

European finance ministers on Tuesday made clear their growing concern about the euro’s strength against the dollar, but said they had not pressed for co-ordinated central bank intervention in foreign exchange markets.

Ministers from the 15 eurozone countries issued a statement on Monday night saying: “In current circumstances, we are concerned about exchange rate moves… We don’t think the recent moves are reflecting economic fundamentals.”

They were reacting to the euro’s rise on Monday to $1.5275, the highest level it has touched since its launch in 1999. The euro has risen by 16 per cent against the dollar in the past year and is also stronger than some eurozone governments prefer against the yen and Chinese renminbi.

Financial market commentators noted that the eurozone statement was similar in tone to that used before the European Central Bank intervened in support of the euro in September 2000.

On Monday ministers drew attention to the fact that Jean-Claude Trichet, the ECB president, had emphasised before going in to the talks that the US authorities had said it was in the US national interest to have a strong dollar.

This was interpreted in financial markets as a warning signal from Mr Trichet about the dollar’s most recent slide against the dollar.

But on Tuesday at least one finance minister, George Alogoskoufis of Greece, said there had been no discussion among his colleagues of joint currency market intervention by the ECB and the US Federal Reserve. “No, no, there was no discussion of that,” he said.

He added: “There is a slight increase in the attention we are giving to currency market developments, because the turbulence continues and this is not something we want. But it does not mean anything dramatic…This is a global problem, it is not a European problem. I don’t think there is anything we can do on our own.”

Jean-Claude Juncker, the chairman of the eurozone finance ministers’ group, also avoided commenting on possible central bank intervention, saying: “I don’t think it would be wise to offer targets to financial markets.”

Some eurozone countries, such as Germany and the Netherlands, contend there are certain advantages in the euro’s strength, in that it is helping to contain inflation, currently at a 14-year high. In addition, they see little impact on the eurozone’s export performance.

Although the European Commission last month cut its 2008 economic growth forecasts for the eurozone, José Manuel Barroso, the Commission president, said on Tuesday the outlook was by no means bleak.

“We face economic headwinds that a few years ago might have been strong enough to sink us. But today Europe is continuing to grow and create jobs. Our employment rate at 66 per cent is our highest ever, and our unemployment rate at 6.9 per cent is the lowest for 25 years,” he said.

Copyright The Financial Times Limited 2008

Gulf Currencies: Time to break free

unpegging from the dollar seems to be the flavour of the decade for monetary policy makers; after emerging economies its is time for the Gulf.

The Middle East's oil exporters should end their currencies' peg to the dollar.

IN THE past week Iran's president, Mahmoud Ahmadinejad, has damned it as a “worthless piece of paper” and China's premier, Wen Jiabao, has moaned that it is causing his country “big pressure”. The dollar's relentless decline—it hit a new low of $1.49 against the euro on November 21st—is prompting jibes from America's critics, jangling investors' nerves and giving policymakers headaches.

Nowhere are the dilemmas more acute than in the Gulf, where virtually all the oil-rich states peg their currencies to the greenback. The combination of soaring oil prices and the tumbling dollar is distorting their economies and fuelling inflation. When the Gulf states meet on December 3rd in Qatar, they should agree to loosen their ties to the dollar.

The argument for linking to the greenback was to provide an anchor for the region's economies, many of which are small, open and financially immature. In effect, the Gulf states import America's monetary policy. The trouble is that a fixed currency makes it hard for oil exporters to adjust to swings in the price of oil. And monetary policy in the world's largest oil-importer is not always right for those who sell the stuff.

Soaring oil prices have brought the Gulf Arabs huge riches. Their real exchange rates, as a result, ought to rise. The simplest way to do that is for the currency to strengthen, but the peg prevents nominal appreciation. Worse, the dollar itself has been falling. The result is rising domestic inflation. Some smaller Gulf economies now have inflation rates of around 10%.

What is to be done? The two most widely discussed options are to revalue or to shift to a currency basket (which Kuwait has already done). By repegging their currencies to the dollar at a higher rate, the Gulf states would alleviate some of today's inflationary pressure. But they would not address the underlying mismatch between any oil exporter and a dollar peg. Switching the peg to a basket of currencies that included, say, the euro and yen as well would give the Gulf states a bit more protection against oil-price swings, but it is hardly a perfect fit. Since most big currencies belong to oil importers, the Gulf States would still be linking their currencies to monetary conditions that may not suit them.

Eventually, the currency pegs should be abandoned. After all, developed economies that are big commodity exporters, such as Norway, allow their currencies to float. In recent years many emerging economies have shifted from exchange-rate pegs to a “managed float”. Instead of aiming for an exchange rate, their central banks have an inflation target. If the Gulf states move to a single currency, as they plan to in the next few years, that currency should surely float. But floating is not feasible in the short-term. These countries have no history of independent monetary policy and few institutions to conduct it.

Look beyond a basket

For the moment, the Gulf states are stuck with a currency peg. But they could do better than the dollar. One intriguing idea is to include the oil price as part of a basket that includes the leading currencies (see article). This would ensure their currencies absorbed some of the impact of oil-price swings.

A big uncertainty is what such a shift would mean for the dollar. In the short term, the effect on the Gulf states' appetite for greenbacks would not be dramatic, since the dollar would have a big weight in any basket. And there should not be a sudden sale of the oil exporters' dollar reserves. The worry is that the end of the Gulf states' dollar peg would send jittery investors into a panic. That risk is real. But with oil prices rising and the dollar falling, the dangers of inaction are greater. The Gulf states need to get rid of their dollar peg now.