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To: Win-Lose-Draw who wrote (173107)	6/16/2002 1:19:24 PM
From: Haim R. Branisteanu	Read Replies (2) \| Respond to of 436258

June 15, 2002 - Euro currency finding its feet but has a long way to go THE June Monthly Bulletin published by the ECB earlier this week gives the impression that the Bank sees the current level of interest rates as appropriate until such time as the Euroland economy shows tangible signs of recovery. This week’s dataflow will not have given much encouragement in this regard with German industrial production coming in well below expectations while new car sales across the Euroland region are down 8% on an annual basis. The recent improvement in economic sentiment in Euroland remains highly dependant on a strong recovery in the US economy this year. Despite the uncertainty about the economic growth outlook, the ECB has raised its projected inflation range for 2002 to 2.1-2.5% after an increase of 2.5% in 2001. This is mainly due to volatility in seasonal food and energy prices, neither of which have subsided as quickly as the Bank predicted earlier in the year. Given that the ECB has an explicit price stability target of 2% inflation, markets are concerned that monetary policy is overly accommodative at present and the ECB may wish to correct this situation by raising interest rates sooner rather than later. The ECB also recognises in its projections that the external environment is the key driver of Euroland growth. Exports continue to act as a buffer against all-out recession while consumer activity remains extremely weak. Against this background, there is much concern that a rapid appreciation of the euro on the exchanges would significantly damage the region’s competitiveness. With the average European consumer unable to take up the slack due to income constraints, the large core economies such as France and Germany look more exposed than ever to developments in the US. With US retail sales disappointing expectations earlier in the week, the ECB’s view that the outlook for the Euroland economy is shrouded in uncertainty is both welcome and justified. The tone of the latest ECB bulletin suggests the Bank is in ‘wait and see’ mode but the next move in interest rates is definitely upward. However, there are two factors in particular which suggest that the Bank is unlikely to take any rash decisions before the Summer break. Firstly, the 6% appreciation of the euro against the dollar since the beginning of the year exerts downwards pressure on inflation. Directly, this is because a stronger euro means that Europeans pay less for imports. Indirectly, a stronger currency reduces export competitiveness which, in turn, dampens growth and inflation. Therefore, an appreciating euro reduces the pressure on the ECB to raise rates sooner rather than later which is consistent with a ‘wait and see stance’. Secondly, French inflation was lower than expected at 1.4% which would have also given the ECB some comfort. Overall, however, we look for Euroland interest rates to end the year at 3.75% with the first hike coming after the Summer break. The appreciation of the euro itself was a key issue for investors this week. For US companies with earnings in Europe, this is a favourable development as dollar profits increase. Conversely, companies who report profits in euros, will see the value of their foreign earnings reduced by translation. The net impact on markets in general should be quite muted. Of course, a collapse in the dollar i.e. a sharp reduction to parity or weaker against the euro, is a completely different proposition and would deal a real blow to US financial assets across the board. However, we continue to view a collapse in the dollar as highly unlikely on a medium-term view. For the dollar to depreciate sharply, capital needs to exit the US at an extremely fast rate. Although there has been an increase in capital outflow from the US since the beginning of the year, the rate has not been alarming. With Japan and Euroland unable to give a guarantee of greater returns than the US, both these regions have only benefited modestly from these flows. Many FX investors are still of the view that if the US does not make it in growth terms this year, there is little hope for either Euroland or Japan. We expect the euro to continue to run into selling at the $0.9510 level over the next few weeks. * Don Walshe is Senior Economist at Goodbody Stockbrokers. examiner.ie