Investment markets have been coming to grips with the reality that the new European currency will begin life on schedule at the start of 1999 with 11 founding members. This has inevitably led to a focus by investors on the 11 equity markets making up this new currency bloc.
However, it would be a mistake to ignore the equity markets of the non-joiners for a number of reasons. First, the non-joiners include countries with very large equity markets relative to their overall Gross Domestic Product (GDP). For example, Britain's total GDP represents 14 per cent of European GDP. However, the market equates to 35 per cent of total European equity market capitalisation.
In fact, the non-euro currency stockmarkets combined are roughly the same size as the eurozone markets even though they account for less than a quarter of European GDP. Therefore, they are likely to get just as much attention as the eurozone markets from investors. From the Irish perspective this is a welcome situation given that most Irish investors will tend to look to the British market when considering overseas investment. Indeed, there are a number of compelling arguments for taking a very positive view of prospective returns from the British equity market in coming years.
Of major significance is that the Labour government is taking a much more positive attitude to Europe than did its predecessor.
This has increased the likelihood that Britain will join EMU by 2002-2003. Already this changed posture visa-vis the euro by the government has been followed up by active encouragement to British business to begin preparing for the possibility of Britain joining the euro.
In fact British business strongly favours early entry to the new currency and many large British corporates have stated that they will begin invoicing in euros from January 1999. This will in turn force many smaller businesses quickly to adapt to the new currency.
From an investment perspective the clear implication of this more positive attitude towards the euro is that British interest rates should over time converge towards the new euro interest rates. No one knows yet what level that might be, but most commentators expect that the euro will have an interest rate structure similar to that of Germany. The table highlights that this would point towards substantial reductions in British interest rates over the medium term. Such a declining interest rate environment would provide a very positive backdrop to the British equity market.
A second positive factor for the British equity market is that the recent weakening in the sterling exchange rate is likely to continue. The British manufacturing sector has suffered a severe loss of competitiveness due to the strength of sterling. This has been reflected in the British stock market where the share prices of many industrial companies have under-performed. As sterling weakens many British industrial companies will gradually regain their lost competitiveness enabling them to increase output and profits. From an Irish perspective increases in their share prices due to higher profits should far outweigh any erosion in capital value due to a weaker exchange rate.
Companies such as GEC and British Aerospace which compete on international markets should benefit from a weaker exchange rate. Other companies which should continue to do well include the drinks giant Diageo.
From a longer-term perspective the likelihood that Britain will eventually join the euro means that Irish investors can look forward to investing in Europe's largest equity market without having to worry about exchange rate risk.
