Stability seen after French vote

September 21, 1992|By Ian Johnson | Ian Johnson,New York Bureau

NEW YORK -- Wall Street analysts predict a return to some sort currency stability today and a possible boost for U.S. stock and bond markets after the French vote yesterday in favor of greater European unification.

Experts saw two main reasons for the probable calm: approval of the Maastricht treaty should allay fears that France will be the next country to drop out of the European monetary system; and last week's turmoil largely anticipated the French vote. But with only a razor-thin margin of victory for European integration, pressure on some currencies likely will continue.

"This is not a rejection of Europe but it does mean that a quick move toward integration of currencies is off the agenda. It is a limp endorsement," said John Lipsky, chief economist of Salomon Brothers Inc.

Mr. Lipsky said the vote means that France will stay a member of the European Exchange Rate Mechanism (ERM) and that the French central bank will defend the franc against speculators. It would now be unlikely that France would join Britain in leaving the ERM, a pillar of European unity that keeps most Western European currencies tied tightly together.

While remaining in ERM would mean high interest rates for France, Mr. Lipsky said he doubted that interest rates could be lowered in any of the countries very significantly to boost Europe's sluggish economy. And even if these countries could somehow drop interest rates by 2 or 3 percent, this would be no panacea.

"Lower interest rates in Europe will no more kick-start the European economy than they did in the United States," Mr. Lipsky said.

Interest rates have been kept high in most European countries because the ERM forces them to defend their currencies if they slip in relation to each other. When Germany's interest rates rose to control the inflation resulting from unification, the value of the mark rose and Germany's neighbors were forced to defend their currencies by jacking up their rates.

Last week, investors and currency lost confidence that Britain would be able to continue following this policy and sold British pounds. The currency tumbled and Britain was forced to leave the ERM. Similar pressures forced Italy and Spain to devalue their currencies.

Kevin Weir, vice president for foreign exchange at Bear, Stearns & Co. Inc., said he expects no such dramatic changes this week. The currency trading markets have already taken the referendum into account, Mr. Weir said, and could actually bounce back now that the feared "no" vote has not materialized.

"We've already had a chaotic week in anticipation of the referendum," he said. "That's behind us."

If no repeat of last week is expected, the developments do prove that Western Europe has a two-tier currency system, with the central or core ERM members of France, Germany, Denmark and the Benelux countries possessing the discipline and fiscal strength to keep up with Germany's high interest rates. Weaker countries, such as Britain, Spain, Italy and Portugal make up a second-tier that may not be able to join a pan-European currency by the end of the decade.

"These countries still have a long way to go before they can converge with the core countries. It may have been premature to think that all could join at once," Mr. Weir said.

These countries' currencies could feel more pressure from investors who feel that these are now ripe for further devaluations. The Italian lira appears especially vulnerable, analysts believe, primarily because the government does not seem able to force through unpopular budget cuts or tax increases.

Another uncertainty about these weaker currencies is that no one knows how much further they will to fall. After deciding to leave the ERM, Britain allowed the pound to drop 4 percent, while the Spanish peseta was devalued 5 percent and the lira 7 percent. More selling of these currencies may continue as speculators seek a new floor and test the central banks' determination to defend the currencies now that the ERM discipline has been relaxed.

"The newly freed currencies will certainly be the big question mark," Mr. Lipsky of Salomon said.

The bond market could benefit from the vote, said several Wall Street analyses. With intererst rates likely to stay high in most countries and growth sluggish, investors would do best with European bonds.

This is especially true of bonds in European Currency Unit (ECU), which is planned to be the new pan-European currency. The market for these bonds virtually collapsed last week when investors thought that Europe might abandon any attempts at further integration. Now that this fear has receded, ECU bonds could rally.

The stock market also could stage a contained recovery, feeding off the predicted euphoria in Europe over the vote, said Bob Walberg, an analyst with MMS International. In a few days, however, domestic ills and the presidential election will return to dominate Wall Street's thinking.

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