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Tuesday, 31 October, 2000, 12:52 GMT
George: Investment weakens euro
Sir Eddie George
Sir Eddie George: a "euro-pragmatist"
Sir Eddie George says the euro's weakness is due to long-term capital flows to the US, not the lack of co-ordination between the European Central Bank and other economic policymakers.

In his testimony to the House of Lords European affairs committee, the governor of the Bank of England said that the US current account deficit of $500bn had been more than financed by $750bn of capital flows from the rest of the world, including investment in stocks, bonds, and acquisitions of US companies by Europeans.

In what was one of Sir Eddie's more positive assessments of the eurozone so far, he said that eventually the high price of US assets would lead to a slowdown in the rate of investment - but in the meantime the US's perceived "fertile environment" for innovation was acting as a magnet for investors.

There was little the ECB itself could do to alter the perception that investment opportunities were greater in the US - although further economic reforms within Europe to boost technological investment was necessary.

Euro interest rates on target

Mervyn King, the deputy bank governor, said there was little criticism of the ECB's interest rate decisions so far.

Longterm interest rates in the eurozone were slightly lower than in the US, pointing to a reasonable degree of confidence by the markets in the prospects for inflation, he added.

Sir Eddie said the "symmetric target" of the Bank of England - which means its aim is to keep inflation within 1% of its target of 2.5% - meant that it was able to respond more quickly than the ECB to the economic slowdown caused by the Asian crisis.

But he praised the quick response of the ECB to the rise in the oil price and its threat to inflation in the past few months.

He said the ECB's credibility would be established by its performance, not greater transparency.

However, he warned that politicians might try to put pressure on the ECB to boost the euro - when in fact that was not part of the bank's central objective.

A 'euro pragmatist'

Sir Eddie said he was neither a eurosceptic nor a europhile but a "euro-pragmatist". And he repeated his balance-sheet evaluation of the pros and cons of euro membership for Britain:

"There is no question that there are potential economic advantages to joining the euro. Nominal exchange rate stability is an advantage - but it is only nominal, and only confined to half our trade... but when I talk to manufacturers they think this would be a wonderful thing and take a lot of risk out of their activity.

"The integration of European capital markets would be an unqualified benefit... I think we will see a lot more liquid markets and narrower spreads - that will be a good thing for everybody.

"The risk is that the 'one size fits all' monetary policy... could lead to tensions. Of course we get sectoral and regional tensions within the UK.

"The issue is how serious those tensions might be within the eurozone... some of the mitigating conditions, for example the movement of labour in the eurozone... is less than it is in the United States."

Without committing himself, Sir Eddie gave the impression that the risks for the UK economy might be greater than that of other countries already in the eurozone.

Euro tensions

Sir Eddie said that within the eurozone the picture was relatively benign at the moment, with the economy expanding strongly.

He pointed out that there were a number of potential tensions, even though these had not caused serious difficulties yet.

According to the governor, there are still differences in the economic cycle of EU countries - depending on whether they are at the beginning of the economic growth cycle or in its later stages.

There were also structural problems, which meant that some countries (for example the UK) might be more affected by interest rate changes than others.

And there were external shocks, for example the high oil price, which might hit some countries, for example Italy, more than others.

But he rejected the argument that Ireland's difficulties were symptoms of wider problems within the eurozone.

He pointed out that Ireland's inflation was boosted by its high dependence on imports from the UK, which have become more expensive as the euro has weakened against the pound.

In response to a separate question, Deputy Governor Mervyn King pointed out that an "optimal currency zone" was a relative concept, but that the core of the eurozone countries now had economic cycles broadly in line.

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18 Oct 00 | Business
Euro slumps to record low
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