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Friday, 22 September, 2000, 13:58 GMT 14:58 UK
Q&A: Turnaround for the euro?
The European Central Bank, the US Federal Reserve, the Bank of Japan and the Bank of England have joined forces to prop up the euro. BBC economics reporters Jenny Scott and Dharshini David explain the intervention:


Is this enough to turn around the single currency's fortunes?

This bout of intervention could put a floor under the value of the euro, but it's probably too early to start talking of a sustained, long term rebound.

The fact that the intervention was co-ordinated between the European Central Bank, the US Federal Reserve, the Bank of Japan and the Bank of England gives it a much higher chance of success.

In addition, now they have intervened once, they are more likely to do it again if need be - for example if the Danes reject euro membership in next week's referendum.

That may discourage investors from selling the euro too readily, which could help to underpin it.

Finance ministers and central bank governors from the Group of Seven industrialised nations meet in Prague at the weekend, and may come up with a statement to add further support to the currency.

Why have the central banks intervened now?

There are three main reasons for intervention now. Firstly, the weak euro was dragging other currencies down with it - such as the pound, the Australian dollar and the South African rand.

That was turning it into a global problem since weak currencies make imports more expensive and therefore boost inflation.

Secondly, the strength of the US dollar was starting to cause problems for US companies. A strong currency makes exports more expensive and can therefore damage sales and profits.

The last thing the American government wanted ahead of the November presidential elections was trouble on Wall Street, hence it would have been more willing to encourage a stronger euro and a slightly weaker dollar.

However, Washington will also be at pains to emphasise that it wants to maintain a firm US currency.

Thirdly, intervention works much better if it is unexpected.

Many traders did not anticipate any moves ahead of the G7 central bankers and finance ministers' meeting in Prague at the weekend, hence were probably caught slightly unawares.

Can it backfire?

This is always a risk. Traders estimate that the central banks have spent around $2.5bn to $3.0bn buying euros, a relatively small amount given that around $1.5 trillion worth of currencies are traded in the foreign exchange market every day.

This probably means they have enough money left in their reserves to enter the market again if need be.

This could have two effects. It could either provide a safety net to the currency, propping it up further, or it could encourage those traders who want to dump their euro assets, to sell, knowing the central bank is a willing buyer.

This is what happend when the pound was forced out of the European Exchange Rate Mechanism in September 1992.

In addition, the fact the ECB has finally intervened having let the euro fall by almost 30% against the dollar, signals they are increasingly concerned about its weakness. This admission could undermine the image of the euro even further.

What does it mean for the US dollar and sterling?

The pound could rise slightly against the dollar.

In recent months, sterling has tended to follow the fortunes of the euro, falling against the dollar as the single currency fell.

Indeed on 12 September, it hit a 14-year low against the dollar below $1.40. Up until a few months ago, the pound was much more likely to track the dollar, as many investors believed the British economy had more in common with the US than with Europe.

And how does intervention on the currency markets actually work?

Intervention is relatively rare and tends to be used only as a last resort.

Central banks have a pool of cash set aside for the purposes of supporting the national currency - in the case of the European Central Bank, that amounts to around 50bn euros.

In this case, central banks in the eurozone, the US, Japan and Britain got together and each bought euros on the foreign exchange market, propping up its value.

Intervention is often unsuccessful because of the sheer size of the currency markets.

It will only work if investors are looking for an excuse to buy the currency anyway. In this case, the euro had already strengthened slightly earlier in the day and so intervention was going with the market flow.

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See also:

22 Sep 00 | Business
Central banks prop up euro
20 Sep 00 | Business
Weak euro hits US firms
20 Sep 00 | Business
Euro tests new lows
19 Sep 00 | Business
IMF calls for euro intervention
14 Sep 00 | Business
ECB warns markets on euro
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