The golden dream of the euro as an alternative to the dollar has tarnished during the currency's first year, as it fails to hold its own not only against the dollar but also against sterling.
Indeed, so great is the difference between the euro and sterling that Irish people travelling to the UK would do well to carry essentials like toothpaste with them rather than face a 20 per cent price differential in British shops.
When the euro was launched in January 1999, economists predicted that it would quickly establish its credibility on foreign exchange markets and assume the status that the deutschmark had in the past and that the dollar has always had. It was also widely assumed that sterling would weaken against the euro. Instead, the opposite has happened. The new currency depreciated by around 14 per cent in its first year and has fallen by another 3 per cent so far this year.
A combination of factors has undermined confidence in the euro. One is the wide variation in performance between the US and the euro zone. Currencies tend to reflect the economies on which they are based, and last year both Germany and Italy, the two largest economies in the euro zone, performed poorly.
By contrast, the US economy is experiencing the largest continuous expansion in its history, and the strong dollar reflects that.
"The euro moved down to reflect the very different circumstances in Europe and the US. But that's what currencies are supposed to do, reflect their economies," says Mr Jim Power, chief economist at Bank of Ireland Treasury. "One of the reasons the outlook for the EU economy is so good for 2000 is the very weakness of the euro."
Other factors that have contributed to the euro's decline, according to Mr Power, are the lack of confidence on the part of the international financial markets in the performance of the European Central Bank (ECB) and its president, Mr Wim Duisenberg, and a series of political mishaps last year, notably the sacking of the European Commission in April and efforts by the German government to bail out the bankrupt construction company, Holzmann. "These sent out negative signals to the markets about the willingness of Europe - and Germany in particular - to restructure their economies," Mr Power says.
But perhaps the most important reason for the weakness of the currency is that global investors have turned their backs on the EU market, preferring to invest in the booming US economy. Theoretically, a weak currency has two effects. First, it boosts exports because goods are now more competitively priced on world markets. This boost, in turn, stimulates economic growth and cuts unemployment. But a soft currency can also make imported goods more expensive and lead to inflation.
In the euro zone as a whole, the weakness of the currency is not a particular problem at the moment and may even be beneficial in boosting growth in stagnant economies. "Most of the 11 euro-zone countries trade with one another. Exports and imports only account for about 12 per cent of total GDP in euro-land, so if the currency falls, as it has done, it doesn't have a huge impact," says Dr Dan McLaughlin, chief economist at ABN Amro. "A lot of European governments are quite happy the euro has fallen because it has boosted growth and cut unemployment."
The Republic, however, is an exception. Nearly 80 per cent of Ireland's imports come from countries outside the euro zone, while almost 60 per cent of exports go outside the zone. "That means the external value of the euro is much more important for the Republic than for anyone else," says Dr McLaughlin. "A weak euro is not welcome for us at the moment because, firstly, it boosts growth - and we're already booming - and, secondly, it could drive import prices higher and fuel inflation. And our inflation is already the highest in the euro zone."
However, a weak euro need not automatically mean inflation in Ireland, says Mr Eoin Gahan, senior economist with Forfas. "Although it makes imports from the UK and US more expensive, it is possible for some of those imports to be sourced from other euro-zone countries."
Such a move would support the Government's long-term political goal of reducing the Republic's economic dependence on UK trade. Currently, the pound is trading at around 76p to sterling. If that had happened before the Republic joined EMU, it is likely the Central Bank would have stepped in and raised interest rates to shore up the pound. But interest rate policy is now in the hands of the European Central Bank (ECB), which has been keeping rates low to stimulate growth in the larger EU economies.
Economists agree that it would be better for the Irish economy if the euro rallied and interest rates rose. For this reason the recent move by the ECB to raise interest rates in the euro zone is welcome.
"For us, it would be better if the euro were stronger," says Mr John FitzGerald, an economist with the Economic and Social Research Institute (ESRI). "In the end, however, the health of the Irish economy depends on the European economy. Most of the goods we sell go to the European market. If they went into recession, there wouldn't be as much need for the goods produced here."
Even ECB interest rate rises are unlikely to boost the euro in the short term. "For the euro to recover, we would need a slowdown in the US economy and a pick-up in European economies," says Mr Power. "The pick-up is in place in Europe, but the slowdown in the US is not. That suggests to me that the euro will remain weak."
