The markets will be closely monitoring the actions of the world's central banks this week after last Friday's dramatic intervention to support the euro.
The intervention by the central banks of the Group of Seven industrialised nations, including the US Federal Reserve and the Bank of Japan, who supported the strengthening of the currency, took the market by surprise. The move had an immediate impact and the euro jumped to $0.90 but by the end of the day had fallen back to $0.8803. The question now is whether this is enough to hold the euro over the key $0.85 level.
A euro recovery would be good news for the Irish economy and would help dampen inflationary pressures. Because of the openness of the economy, the cost of imported goods from outside the euro zone has a large impact on inflation. According to the ABN Amro chief economist Dr Dan McLaughlin, if the euro has now found a floor value and oil prices have peaked, the outlook for Irish inflation is much improved.
Analysts are divided on the likely effect of Friday's action. Some suggest that further substantial intervention will be needed, as the reasons for selling the currency have not changed.
However, such suggestions may be slightly too negative. After all, many currency traders were caught offside on Friday. Traders who had been selling the currency for some time lost out substantially as the currency rose. They are likely to be uneasy about selling it down too quickly, in case the central banks enter the market again.
Therefore, ECB may well have succeeded in putting some floor under the currency. Nevertheless, over the longer term, the euro could well be pushed lower.
In addition, according to Mr John Beggs, chief economist at AIB, the markets do not have the same appetite for risk as they did some years ago, with fewer hedge funds now active in the currency market. Therefore, large investment houses may be unwilling to take on the central banks, particularly as the euro has already fallen a long way and there is some agreement among analysts that it is undervalued.
It is not yet clear if the central banks will go into the markets again today or later this week. Analysts and investors say more intervention is on the cards, although ECB president, Mr Wim Duisenberg, said there was "no strategy to continue and continue" and the British prime minister, Mr Tony Blair, said yesterday that further moves were "not anticipated".
But, as last Friday's move showed, the central banks like is to surprise the market and speculative traders in particular. According to Mr Beggs, the central banks will have to come back into the market if the currency drifts again. "The market will probably allow it to drift lower but, if it comes close to $0.85, further intervention will be put in place," he said.
He added that it is still too early to talk about the euro changing course - for this to occur, it will need evidence of a downturn in the US economy and further progress towards structural reforms in Europe. However, he said, the euro is likely to move between $0.85 and $0.90 in the coming weeks.
A key problem for the banks is the disagreement over how early and how much Europe's own governments were involved in the intervention. Politicians and central bankers are both saying they were responsible for Friday's decision to prop up the euro, undermining the credibility of the ECB in the markets' eyes.
The Italian Treasury Minister Mr Vincenzo Visco said the action "put in practice a decision" made by euro zone finance ministers at a September 8th meeting in Versailles. But Mr Duisenberg said "certainly not". The talks, which he didn't attend, had "no impact" on the concerted purchase of euros by the world's leading central banks, he said.
Yet French officials maintain that ministers in Versailles gave the ECB an initial mandate to intervene if the euro were to drop further than it was at that time. With Mr Duisenberg sitting next to him, Mr Fabius, the French finance minister, told reporters yesterday that the ministers and the central bank each had a "role" in determining currency affairs.
The differences are the latest sign of European discord on economic and monetary affairs and could take some of the positive impact out of Friday's move.
The markets will also be looking ahead to the referendum on whether Denmark should join the euro on Thursday. Danish support for the euro is gaining ground, according to new polls. Those opposed to the euro lead the polls by just 3 percentage points, Gallup said, compared with about 12 points last week. If the `yes' camp wins, the euro is likely to rebound by a couple of cents, Mr Beggs said.
