The euro has slipped below $1.05, yet another lifetime low and some 13 per cent below its peak shortly after launch in January. Speculation is growing that before long it will be trading at parity with the US dollar. In the short term it is hard to see what could halt the currency's slide. Even intervention - whether by central bankers trying to talk up the currency or even stepping in to buy it in the markets - is unlikely to succeed. Comments yesterday by senior Bundesbank figures led only to a brief rally, before the currency weakened again. Many of the euro zone governments will privately welcome the decline. A weak euro is in the interests of most of the larger euro zone economies, which are growing very slowly and are in need of the export boost which a weak currency brings. For this reason, the markets believe that policy-makers are adopting a policy of "benign neglect" to the currency.
The current weakness of the euro is largely a reflection of fundamental differences in the US and European economies. Germany and Italy are both close to recession while even the latest data from France has not been encouraging. Ireland is, of course, in a different position, but rapid growth here is very much the exception in the euro zone. The US, on the other hand, remains strong and the Federal Reserve Board has signalled that higher interest rates could be in prospect. Most investors also have far greater confidence in US policy-makers than in their European counterparts, which recent about-turns from European central bank president, Mr Wim Duisenberg, among others, will have reinforced.
The main catalyst for the latest recent bout of weakness was the decision of EU ministers to allow the Italian government to run a larger than expected budget deficit. While there is an argument that this was the correct decision in the Italian case, it raised questions about how seriously policy-makers are taking the stability and growth pact, the agreement on how national budgets should be managed in the euro zone. The Italian budget difficulties are hardly a surprise. Even a year ago, many believed that Italy would not be able to squeeze its budget enough to meet the criteria for entry to the single currency. While it did the trick in time, slow economic growth is now threatening its promises on debt reduction.
The stability and growth pact, which was negotiated in Dublin, has been criticised for possibly being too strict, with the risk that tight budgetary rules could limit policy options in an economy heading for recession. There is an argument to make it more flexible, while still retaining reasonable budgetary discipline. But if the rules are to be altered, then a clear decision needs to be communicated to the financial markets. If, on the other hand, the pact is to be chipped away at, confidence in the coherence of economic management will be undermined and the euro's prospects damaged. There are grounds for hope that the euro may recover in value eventually. Much of the strength of the US dollar is based on stockmarket strength. Should that start to falter, attention may quickly turn to the massive trade deficit which the US is now running with the rest of the world. But in the meantime it is essential that Europe's policy-makers have a clear approach to managing the currency and the euro zone economies.