The euro may be looking forward to a brighter future. Since its introduction in January 1999, the currency has almost constantly lost value. The European Central Bank's (ECB) credibility has been questioned by some, while a few have even questioned the whole project's validity. Certainly the currency has seen some bad times and no one predicted it would fall more than 30 per cent from its initial highs. But 2001 may be the year that its fortunes turn. Markets tend to follow momentum and do, of course, overshoot. Until very recently, traders found little reason to buy the currency - and every time they did they lost money.
In the past few months that changed. The euro did not appreciate significantly but you were as likely to make money buying as selling the currency. If the trend is now towards appreciation, the markets are likely to follow it. There are also few, if any, economists or market watchers who believe the euro is fairly valued. Under almost any value measurement or measure of purchasing power parity, the currency has overshot. As Dr Dan McLaughlin, chief economist at ABN Amro points out, the other key to the euro is the direction of long-term capital flows. For much of 1999 and 2000, money was gushing out of Europe and into the US.
Pension fund and investment fund managers were rebalancing their portfolios and buying large amounts of US stock. The motivation for the move was similar to the large-scale sell-off in Irish equities by fund managers here. After the single currency, they simply had too much stock in one currency and wanted to rebalance their portfolios.
This was added to by corporates with several large US investment fund houses being taken over by Europeans. Billions of euros flowed into the US as a result.
The signs are that this process has slowed down. Money is still leaving Europe but not at the same rate. If much of this business has been done, then short-term and long-term investors may have a reason to once again buy euros. If so, the only way forward is up. But the question is how far?
According to Mr Colin Hunt, chief economist at Goodbody Stockbrokers, the omens are good. He points out that it is likely that the euro zone will grow faster than expected and the US less quickly next year. "We will get a gentle appreciation to around $0.93 to $0.95," he predicts.
"But a breach of parity is not on the cards as the European economy is still sluggish and needs support from lower interest rates and a low currency."
According to Mr Hunt, the global economy is likely to slow down next year. Growth is moderating in the US and the UK, while strong growth in Asia following the 1997 crisis there will begin to slow.
The price of oil will also be crucial. It has been falling back and stabilising in the past few months and if that continues, it reduces one of the main inflationary pressures on the consumer price index and could actually have a deflationary effect on longer-term growth prospects.
This combination should ensure that euro zone interest rates do not fall by more than one-quarter of a percentage point next year. Whether another rate rise will be implemented before that is an issue over which analysts are divided. On the other hand, the US Federal Reserve is expected to cut rates by as much as half a percentage point in response to the economy slowing down. That would narrow the interest rate differential between the two and would make the dollar slightly less attractive. Growth differentials are also likely to narrow. Euro zone gross domestic product grew by 0.7 per cent in the third quarter, just ahead of the US.
This is the key difference between the Fed and the ECB, according to Dr McLaughlin. The Fed will cut rates to stop the economy slowing too quickly but the ECB, with an inflation-only target, probably will not. As a result, it is possible that US growth could begin to pick up again towards the end of the year. This occurred previously, in 1995 and in 1998, and it could mean any resurgence for the euro would be short lived.
