The latest events on the foreign exchange markets have created something of a dilemma for the Central Bank. The weakness of sterling has coincided with a period of strength for the deutschmark and the pound has been caught in the middle. The Irish authorities, it would appear, do not want to see the pound falling too far against the deutschmark bloc and the Central Bank has been buying the currency in the market to try to strengthen it in value. However, this has also shad the effect of pushing the pound to almost 104p, sterling, a level which if sustained could cause some difficulties for exporters to the British market.
The root cause of the latest disturbance on the market has been the weakness of the US dollar, a development which has contributed to upheavals in EU currency arrangements all too often in recent years. The nervousness about US share prices has, in turn, been behind much of the weakness of the US, currency. Because of the traditional trading relationship between Britain and the US, sterling tends to fall when the dollar is weak. Meanwhile, investors' funds moving out of the dollar would often switch into deutschmarks, thereby strengthening the German currency.
Ideally, the Government and the Central Bank would wish to see the pound remain firm against sterling but not rise too rapidly, while maintaining a value close to the deutschmark, in the EU exchange rate mechanism. However, when sterling moves one way and the deutschmark moves the other, this is not easily achieved. Over the past week or so the Central Bank has indicated that its priority is to see a firm link with the deutschmark bloc. On a number of occasions it has intervened in the market by buying Irish pounds to try to support its value against the German currency. One motivation may be to try to maintain a stable currency in the ERM ahead of next year's decision on who will qualify for the move to a single currency.
The difficulties faced by the Central Bank are nothing new. Similar developments lay behind the currency crisis of late 1992 and early 1993, although back then the situation was much more serious, with the pound reaching 110p sterling at one stage and constantly hitting the floor of the ERM band. Looking to the future, the pull between the sterling influence on one side and the desire to be part of the Continental currency group on the other are also central to the debate now underway on the single currency.
The Government has committed itself wholeheartedly to qualifying for the single currency and is on course to achieve this goal. At the moment, the Irish economy appears to meet the Maastricht qualification rules although the wording of these rules is far from precise. The Government is committed to continuing to meet the criteria by keeping the public finances and inflation under control and maintaining a firm currency policy.
However, a debate is still required on how best to prepare for membership of the single currency and in particular how to introduce the kind of flexibility into the economy which will be required when the exchange rate can no longer adjust. The long term challenge of continuing to increase the productivity of all areas of the economy must also be addressed. The forthcoming report from the Economic and Social Research Institute on Ireland and EMU should provide the raw material to allow discussion on these issues to start in earnest.