What does revaluation mean?

Revaluing means increasing a currency's central rate in the European exchange rate mechanism (ERM). The ERM is designed to set limits to the extent to which member currencies can fluctuate in value against each other.

As part of this arrangement, each currency in the ERM has a central exchange rate, or central rate, set against each other currency. For example, the pound's central rate against the deutschmark is DM2.41.

Why are central rate's important?

Under the ERM rules, each currency can only vary in value against any other currency by 15 per cent either side of a central rate. For example, the pound can trade between about DM2.076 and DM2.80. against the German currency. Each ERM currency has a similar upper and lower limit against each other currency. The limits of fluctuation against the central rate used to be much narrower - 2.25 per cent on each side of the central rate - but this old narrow band was abandoned in August 1993 after months of currency turbulence.

Why are the central rates again the focus now?

EU leaders are now starting to examine what mechanism will be used to fix the rates at which currencies will enter monetary union. One of the favoured mechanisms for doing this would be to use the existing central ERM rates.

What would this mean, exactly?

This would mean that when the different member state currencies entering monetary union on January 1, 1999, their currencies would be irrevocably tied together at the existing central ERM rates. So the pound would be fixed at DM2.41 and at its central rate against all the other EU currencies. Other mechanisms for setting currency rates may also be considered, although the central rates appear the most likely at the moment.

Under the ERM plan, the pound and all the other currencies would remain in circulation for about three years, before being replaced by euro notes and coins.

Would this suit Ireland?

Not as things stand. At the moment the pound is trading around DM2.68 to DM2.70. This is way above its central ERM rate of DM2.41. So if the single currency started tomorrow and this mechanism was used to fix exchange rates, then the pound would have to fall sharply in value against all the other ERM currencies. Exporters would be delighted, but it would push up import prices and could fuel inflation.

Is there a way out of this dilemma?

There is where the speculation of a revaluation of the pound's central rate come in. By revaluing the pound's rate upwards, it could allow is to join the single currency at a rate closer to that at which the pound is currently trading on the market. But the problem is that it is impossible to forecast what way international currencies will move in the 16 months left before the currencies are actually fixed. From the Irish point of view, the key issue is what will happen to the value of sterling. The main reason why the pound is so strong against the other ERM currencies is that sterling has risen sharply and pulled the pound up with it. If we revalued now and sterling subsequently collapsed, then the risk would be that the pound might have to lock in to the single currency at a rate well above parity.

What would revaluation mean for the rate at which the pound is actually trading at the moment?

For the public changing currencies and companies trading overseas, the immediate impact of a revaluation on the pound's exchange rate is not clear. It would not necessarily mean an increase in the pound's value on the markets.

Given that the currency is already trading so far above its central rate, a revaluation would not necessarily have any immediate impact on its market exchange rate. For example a 5 per cent revaluation would bring the currency's central rate to around DM2.52, still well below its current exchange rate. So even if the central rate were revalued, it is quite possible that this could be followed by a fall in the rate at which the pound trades against the other currencies. The new central rate might act as a floor below which the currency would not fall in future and it would obviously set an important marker for the rate at which we would enter monetary union.

So what is the Government likely to do?

Irish policy-makers will hope to avoid having to make a decision on the issue for as long as possible. By doing so, they may reckon that sterling may head downwards in the months ahead. This could lead to a fall in the pound's rate in the ERM, perhaps even making a revaluation unnecessary.

However much will now depend on the decisions at EU level in the months ahead and how quickly the other states want to push ahead on deciding how the entry rates for the single currency will be set.