The Bundesbank president, Dr Hans Tietmeyer, has hinted clearly that he believes the pound may be revalued in the EU exchange rate mechanism to allow it to join monetary union at an appropriate rate. His remarks have highlighted the problematic issue of the pound's rate of entry into monetary union, which is now set to be a focus of market attention over the coming months.
Dr Tietmeyer, speaking in Frankfurt, said that in the run up to the final locking of currencies it would be possible for one currency to be revalued. While he did not mention the pound by name, the Irish currency is seen as the only candidate for a revaluation because of its recent strength in the ERM band. Market analysts were in no doubt that he was referring to the pound.
The comments from the Bundesbank president, made to journalists in Frankfurt late on Wednesday evening, supported the Government bond market yesterday. This is because it helped to allay the fears of international investors that the value of the pound would fall sharply in the run up to joining the single currency, which would hit the value of their pound investments. The Bundesbank president's comments came in response to a question about how exchange rates would be set for the different currencies joining monetary union.
He said there were arguments in favour of current central rates in the ERM band. Most of the currencies of the prospective EMU members are trading close to those central ERM rates. However, the pound is well above its central rate, trading yesterday at DM2.67, compared to its central rate of DM2.41.
The pound's strength in the ERM has led to intense speculation about the rate at which the Irish currency will enter monetary union. If the existing ERM central rates are used to calculate the exchange rates for entry, then the pound would have to fall sharply from its current level. However, such a decline in the pound's exchange rate could fuel inflation by pushing up import prices. So many analysts are forecasting that the pound's central rate in the ERM band could be revalued upwards to somewhere between DM2.50 and DM2.60 to allow the Irish currency to join monetary union at a more realistic rate. Dr Tietmeyer's comments are important, as they suggest that this revaluation option has been discussed at European level and that the Bundesbank would not oppose such a move.
Reuters reported that the Bundesbank president said there were arguments in favour of using central rates and that in this context "the revaluation of a single currency is still possible." The Government here is maintaining a strict "no comment" policy on the revaluation question. However, it is unlikely to want to make an early decision on the issue, as doing so might leave the pound exposed, if sterling were to fall sharply.
Sterling's recent strength is the main reason why the pound has risen so sharply in the ERM band and if sterling fell back sharply a revaluation of the pound might not be necessary.
In a comment which will be welcome to the Government and the Central Bank, Dr Tietmeyer said that the view was growing that a decision on how rates should be converted might be taken early next year, at the same time as EU leaders decide on which states will join. This would suit Ireland, as an earlier decision would have led to market pressure to clarify the position of the Irish currency.
Mr Eunan King, economist at NCB stockbrokers, said that Dr Tietmeyer's comments appeared to pretty much rule out the possibility that Ireland would join monetary union at its current DM2.41 central rate. Mr Kevin Daly, economist with Ulster Bank markets said that Dr Tietmeyer had implied that no decision on conversion rates would be taken at next month's meeting of EU finance ministers, but that "revaluation is now a definite possibility."
