Tarnished euro still brightens business

A 10 percent drop in currency's value fuels mergers and exports in

The party to celebrate the birth of the euro didn't last long. Europe's new single currency peaked three days after its Jan. 4 launch, but its value has fallen steadily against the US dollar and the British pound ever since.

Now worth about $1.07 - down nearly 10 percent from its high of $1.18 - the euro could soon be worth less than a dollar, some experts predict.

That would be a psychological blow, and galling to some European politicians. But the euro's fall leaves European bankers and analysts unfazed.

"The euro's value is not yet a problem," says Kristof Heydrich, an economist with Commerzbank in Frankfurt, Germany. "I am not pessimistic about the euro in the longer term."

Reasons for the European currency's weakness against the dollar are not hard to find: The US economy continues to steam ahead at astonishing growth rates, posting an annual rate of 4.5 percent in the first three months of this year.

On the other hand, economies in "Euroland" - the 11 countries that share the euro - will be fortunate to enjoy a 2 percent growth rate this year, according to International Monetary Fund (IMF) predictions.

That picture is reflected in interest rates on either side of the Atlantic. The US rate, which Federal Reserve policymakers decided to leave unchanged Tuesday, is nearly double the European rate, set last month, of just 2.5 percent. This makes dollars a more attractive investment.

Nor has the conflict in Kosovo helped.

War in Europe does nothing to boost international investors' confidence in a European currency. But it does not pose a real threat to the euro in the longer term, analysts here believe.

It is unclear what the overall costs of the war will be - or how much it will cost European countries to help rebuild Yugoslavia and resettle refugees afterward.

But the fighting no longer threatens to weigh heavily on European government budgets, says Paul Horne, a London-based analyst with financial services firm Salomon Smith Barney.

"Kosovo was a big black cloud when there were fears that it might turn into a land-war quagmire," he says. "But as that prospect recedes, the cloud will be lifting from here on out."

International investors are worried, however, by deeper underlying trends such as persistent high unemployment in Europe, especially in Germany, where successive governments have shied away from reforms to make the labor market more flexible.

European Central Bank president Wim Duisenberg made the point when he announced last month's interest-rate cut, and said that European politicians could not blame the ECB's interest-rate policy for joblessness.

"The unacceptably high rate of unemployment is due to structural factors and inefficiencies in markets for labor," he argued.

The falling euro may have hurt European pride, but it has actually helped European economies in a number of ways.

Most obviously, it has made European exports cheaper on world markets than they would otherwise have been, boosting exporters' business. Indeed, if the euro had held its value, Euroland's economic growth would have been even more sluggish than it has been.

AT THE same time, the euro's creation, and the creation with it of a single capital market, has contributed to a wave of mergers and takeover bids that has swept some of the Continent's biggest and best-known companies in recent months.

Italy's Telecom Italia and Germany's Deutsche Telekom are hoping to merge if a separate deal falls through, the three largest French banks are involved in a takeover tussle, chemical giants Rhone Poulenc and Hoechst are to join forces, and a host of other restructuring operations are under way.

Monetary union in Europe has not only enhanced competitive pressure, says Mr. Horne, "but when international investors can pick and choose the best prospects in a single market, you have to compete for their money."

Certainly, professional investors do not seem worried by the euro's fall. The big investment houses have increased the amount of euro-denominated bonds so far this year from 28 percent of their total holdings to 41 percent, according to a survey by London-based newsweekly The Economist.

At the same time, Euroland stocks - now all denominated in euros - have not done badly.

The euro equity market is worth 8.7 percent more today in euro terms than it was when the currency was launched, which compares respectably to the 10.6 percent jump in the capitalization of the US equity market.

With economic analysts expecting something of an upswing in European economies later this year, and predicting that US growth rates will have to slow at some point, they say prospects for the euro are brightening.

That would certainly boost the new currency's credibility.

"The euro is now entering an important phase of its existence," says Commerzbank's Mr. Heydrich.

"It is under inspection and must prove that the hopes people put in it were right. Many investors are still hesitant."