The most recent cut of 1.25 per cent in interest rates engineered by the Irish Central Bank highlights the reality of European Monetary Union which is now only a few weeks away. Irish interest rates have virtually converged on German rates and a further modest cut of 0.4 per cent in Irish short-term rates before Christmas will see the culmination of the convergence process.
As time goes on, the new euro zone consisting of the 11 EMU countries, will be increasingly viewed as a single economic unit. So what is the economic and financial outlook for the new "euroland"?
International Monetary Fund forecasts indicate that growth will be faster in Europe than the US, Britain or Japan. The key factors underpinning this relatively favourable economic scenario are:
demand growth in euroland is largely domestically driven by the consumer who is only modestly impacted by the slowdown in emerging markets;
monetary policy is accommodative - the convergence process will have cut about 0.5 per cent off average euro short-term interest rates by Christmas - expectations for 1999 are that the new European Central Bank may shave rates even further:
on the political front there has been quite a strong shift to the left so that European governments are now dominated by politicians with policies aimed at promoting economic growth and reducing unemployment.
Germany, France, Italy and Spain account for about 80 per cent of the new euroland's GDP and population so that the economic health of these four economies will ultimately set the pace and direction of EMU economic growth in 1999.
German economic expansion has become reasonably broad based with a drop in exports being more than offset by strengthening retail demand from the German consumer. This should remain strong throughout 1999 due to the favourable combination of falling unemployment, rising real incomes and anticipated tax cuts.
The main uncertainty in Germany is how the new coalition government of Social Democrats and Greens will perform. There are genuine fears in the business community that corporate profitability will be damaged by the new government's taxation policies. However, the negative impact of higher corporate taxation should be largely offset by the pro-growth stance of the new government.
In France consumer confidence remains high with consumption growing by more than 4 per cent per annum which is the fastest rate of growth since 1986. Falling unemployment has been the key to stronger consumer demand. The French unemployment rate is still quite high, at 11.8 per cent, but the Socialist government is committed to reducing the jobless total. Despite the deterioration in the global environment French domestic demand should continue to grow strongly during 1999.
The story in Spain is similar with declining unemployment fuelling growth in consumption. Spanish unemployment is still very high at 18.6 per cent although it peaked at 22.9 per cent in 1996. Spain has been a major beneficiary of lower interest rates which have served to stimulate a boom in investment. Therefore, both consumption and investment should be growing strongly in Spain during 1999.
Of the big four euro zone economies, Italy is the only one where the climate is somewhat uncertain. Forecasts for Italian growth in 1998 have been scaled back to 1.8 per cent and 1999 will probably be even slower. Persistently high unemployment has undermined consumer confidence while the Italian economy continues to be dogged by political uncertainty and a high public sector debt.
From the Irish perspective the most striking aspect of this review of the new euro zone, is the relative improvement made in Ireland over the past 10 years in terms of much reduced debt and increased employment. While the financial and stock market turmoil of recent months will undoubtedly have some negative impact, the euro zone looks like it will start life with a high degree of economic stability.
