One year with the euro
Speech delivered by Dr Sirkka Hämäläinen, Member of the Executive Board of the European Central Bank, Europäisches Wochenende Berlin 2000, Berlin, 8 January 2000
First of all, I should like to say how glad I am to have this opportunity of speaking in Berlin, a dynamic and rapidly developing metropolis which, in many ways, symbolises the spirit of European integration and our hopes for the new Millennium.
Today is the eighth day of the new Millennium and I think it is natural to look ahead, at the future challenges and prospects for the development of the financial industry in Europe on the basis of our recent experiences.
We have now lived with the a new currency - the euro - and a new central bank - the Eurosystem (comprising the European Central Bank and the national central banks of the 11 participating countries) - which is responsible for the common monetary policy of the euro area, for one year.
Clearly, the single currency was born under favourable conditions: There was already a firm commitment to enhanced political integration in Europe and a broad consensus on the need to pursue stability-oriented economic policies aimed at price stability, fiscal discipline and structural reform. The participating countries had achieved a high degree of nominal convergence and they had also started to tighten their co-ordination and co-operation in the areas of fiscal and structural policies.
One year is clearly too short a period of time to make a definitive assessment about the performance and effects of the new currency. The benefits of Economic and Monetary Union are predominantly of a long-term and structural nature. Therefore, the attempts - which we have often seen in media over the last year - to measure the degree of success of the new currency only in terms of its external value are totally inadequate and misleading.
In fact, the introduction of the euro is not yet complete. Only when the euro banknotes and coins are introduced in 2002 will we be able to see the wider effects of the new currency, such as increased price transparency, lower transaction costs and improved competition in the markets for goods and services. The political and symbolic effects of a single currency, which are already evident, are bound to strengthen further and will gradually deepen and widen European integration.
I would like to try to summarise some of the most important aspects of the euro's first year.
A first observation is that the Eurosystem's decision-making and operational procedures have worked very smoothly and efficiently. The implementation of monetary policy was conducted without any problems. The single monetary policy has guaranteed price stability and has, at the same time, been supportive to the revival of the euro area economy. The conduct of a well-balanced monetary policy has thus contributed to strengthening the credibility. The institutional independence is a very important factor behind this credibility. The Eurosystem has proven to be a truly independent institution, completely devoted to its primary objective of achieving price stability and with the power to take and implement decisions efficiently.(1)
With regard to its operational efficiency, the Eurosystem has clearly benefited from the national central banks' considerable experience in dealing with their national counterparties. The operational framework is market-oriented, modern and flexible. It comprises many different instruments and parameters, and the collateral base is wide. This flexibility was particularly useful and visible in the context of the Century Date Change. We did not need any special instruments or facilities to meet the challenges of the year 2000. I am proud to say that the transition to the year 2000 in the European financial markets took place very smoothly.
A second - and, as such, natural - observation is that the euro immediately became one of the world's leading currencies for investment and trade. The euro is one of the main currencies in the foreign exchange markets, with euro/US dollar trading the most active and liquid market segment at the global level.
The international role of the euro is also reflected in its popularity as an issuance currency for international bonds. Preliminary statistics show that euro-denominated bonds accounted for some 40% to 45% of the volume of new issues during the first three quarters of 1999, roughly matching the market share of bonds denominated in US dollar. It is also reflected in the increasing popularity of the euro as an anchor for other currencies. More than 50 European and African countries have adopted foreign exchange arrangements in which the national currency is linked - in one way or another - to the euro or to a basket of currencies in which the euro is an important component.
Despite the popularity of the euro as a currency for bond issuance and as an anchor - or pegging - currency, we have not yet witnessed a corresponding interest in the euro on the investors' side. It is natural for investors first to want to see and carefully assess developments in the new currency area and its financial markets. The euro area capital markets are still suffering - in spite of their rapid development - from a lack of efficient integration. In addition, there are still many uncertainties as to the structural developments and policies affecting the future of the euro area economies.
As a third observation, I would like to emphasise that - although it has not yet been completed - we have experienced the rapid establishment of a largely integrated, efficient and liquid money market encompassing the whole euro area. We have also seen a rapid integration process in other segments of the financial markets.
The integration of the money market was a necessary precondition for the implementation of the single monetary policy, since it enables arbitrage to eliminate any cross-country differences in money market interest rates. A crucial element in this money market integration was the successful implementation of the TARGET system, operated by the Eurosystem. It links all the real-time gross settlement payment systems in the European Union, thereby making it possible for banks to transfer and access funds throughout the euro area.
As to the integration of other segments of the financial markets, the pace has been much slower, even though some progress is visible here as well.
European financial markets have naturally suffered from a high degree of segmentation and a lack of cross-border competition, low trading volumes, high costs and a reluctance to introduce innovative financial instruments. This segmentation was very much a result of the currency "barriers", but other factors also played a role. Different traditions and practices, national regulations and tax regimes have been - and still are - further obstacles to the efficient integration of the financial markets in Europe.
This leads me into the forward-looking part of today's presentation. What are the challenges and prospects for the future development of the European financial markets?
In this context, I would like to explain why the Eurosystem has a keen interest in the development of the financial markets in the euro area.
First, a key requirement for the efficient achievement of the primary objective of price stability is that monetary policy impulses are transmitted in a smooth and homogeneous way throughout the whole euro area. Efficient and integrated money and bond markets are important in order to achieve this.
Second, the development of these markets contributes to a more efficient allocation of resources in an open market economy with free competition. This is very much in line with the spirit of the Treaty on European Union (i.e. the Maastricht Treaty). An efficient allocation of savings is important in order to achieve higher real investment, especially in the most innovative sectors of the economy.
It is clear that the current institutional and market arrangements in the euro area are not enough for the development of deep, integrated and liquid markets. In the new regime, many parts of the institutional frameworks, which were functioning well within individual countries, are now becoming obsolete or are inconsistent with the schemes prevailing in other countries. Hence, old rules and market architectures have to be adjusted and harmonised in order to ensure a higher degree of efficiency.
The integration, liquidity and efficiency of the financial markets are so essential for the success of the euro project that it is worth giving a brief overview of the current state of development of the main market segments, and thus of the opportunities available to the investors in these markets.
Despite the fast integration of the money market, far less progress has been made in the segment closest to it, the repo market. There are several reasons for the lesser degree of integration in the repo market, as compared with the unsecured money market, such as the different features of the underlying bonds (i.e. their credit risk and market liquidity), a lack of harmonisation of repo agreements throughout the euro area as well as the technical difficulties related to the cross-border management and settlement of collateral.
This notwithstanding, we are witnessing promising developments in the market. The consolidation of clearing and settlement systems is underway and the repo market is benefiting from improving liquidity in the bond markets and also from indirect effects of increasing liquidity in the unsecured interbank market and the swap and futures markets.
The changes experienced so far in the short term securities markets are still very limited. Previously existing markets in the euro area were generally small and very unevenly developed across the various countries. It is likely that it will take a longer period of time for these markets to take off.
As to the bond markets, the changes implied by the introduction of the euro are more complex than those affecting the money market. Government bond markets are now highly integrated owing to the relative homogeneity of the issuers and to a converging trend of issuing practices towards best standards. In addition, increased competition across the borders contributes to an improvement in the functioning of the secondary markets. As a consequence, the liquidity of the government bond markets, which is reflected, inter alia, by the much larger average size of the issues, has risen.
With regard to private bond issues, it is worth noting that markets for mortgage-backed securities (the so-called Pfandbriefe market), which was traditionally restricted more or less to Germany, are now developing in several other euro area countries, such as France and Spain. We have also witnessed a growth of the so-called "Jumbo" sector of the Pfandbriefe market, which contributes to an increased market liquidity for these kind of securities.
In the corporate bond market, a sharp increase in the issuance volume has occurred over the last year, with a broadening of the range of institutions resorting to the bond market for funding. In particular, the increase of issues with lower credit ratings is an encouraging step towards the development of deep and liquid corporate bond markets, which will be of particular importance for small and medium sized innovative companies - the so called growth companies - to raise funds.
Despite the recent progress, we should not shy away from the fact that there is still much work to be done in order to remove barriers to a further market integration.
Of particular importance for the development of the euro area financial markets will be the development of harmonised - or at least mutually consistent - legal documentation. Legal initiatives are also necessary in other fields, such as in the cross-border use of collateral, in an upgrading of the Investment Services Directive, the improvement of the conditions for raising capital on an EU-wide basis, the creation of a level playing-field for pension fund supervision, a secure and transparent environment for corporate restructuring, etc.
Another important area is the establishment of improved technical possibilities for the cross-border management and settlement of collateral. The implementation of links between securities settlement systems would enable the simultaneous settlement of both the cash and the securities components of transactions. These links are not being implemented primarily for cost reasons. The fragmentation of the infrastructure for securities settlement systems in the euro area is, in fact, striking: there are currently 29 different systems. A virtuous circle can be expected whereby the growth of the securities markets in the euro area will make the integration and consolidation of these systems easier, thereby simplifying cross-border transactions and thus supporting the further attractiveness and growth of the securities markets.
The responsibility for eliminating the differences which separate the markets and for creating an environment conducive to further integration - and thus to more efficient and competitive financial services - lies largely with Community institutions and the national governments. Against this background, the European Commission's "Financial Market Action Plan", as endorsed by the Heads of State or Government at the European Council meeting last summer, constitutes one very promising initiative. But we should not forget the important role of the private sector. European market organisations play an essential role in the achievement of a harmonisation of market practices, legal documentation, etc.
The need for improved competitiveness is not restricted to the wholesale business. The retail banking sector in Europe is suffering even more from national segmentation. Banks do not yet offer adequate retail services on a pan-European scale. But we believe that we will see clear improvement in these services, at the latest when the euro coins and banknotes are introduced in 2002. So far, we have only seen the modest beginnings of a reshaping of the European banking sector. Market forces and intense competition will foster consolidation and improved services in a cross-border perspective.
In conclusion, I should like to emphasise that any assessment of the performance of the euro would have to be based on a much wider analysis than only the short-term fluctuations of the exchange rate. The preservation of internal price stability and the purchasing power of the euro are the main criteria for evaluating the success of the new currency. However, in order to give a broader picture of the success of the euro, it is also necessary to assess the structural effects of a single currency, such as its role in fostering the efficiency and competitiveness of the European financial markets, and the European economies in a wider sense. With this perspective, there is no doubt that the introduction of the single currency has been very successful and that it will bring important benefits for the participating countries.
In fact, the benefits of the single currency are most immediate and evident in those smaller countries, such as Finland, which did not have a long track record of stability-oriented policies. The establishment of Economic and Monetary Union made it possible for these smaller countries to consolidate their credibility more rapidly by drawing on the reputations of some of the larger EU Member States, in particular Germany. At the same time, it is important to remember that, in the global context, even the bigger European economies are rather small and vulnerable. For the future, the credibility and the competitiveness of the euro area are crucially dependent on the fiscal discipline and structural policies of the countries participating in Economic and Monetary Union. Naturally, the policies of the bigger countries will have a particular importance for the euro area as a whole.
The smaller countries have traditionally suffered more from the strict national segmentation of the financial markets in Europe than the bigger countries. The single currency and the related market integration process are contributing to an increased interest by international investors to diversify their portfolios also into the smaller economies of the euro area. At the same time, the deeper and wider financial markets will enhance the possibilities for companies throughout the euro area to find suitable financing and risk cover at a lower cost than before. Finally, the elimination of foreign exchange risks in cross-border trade and investment within the euro area will contribute to increased competition in the goods and services markets. The benefits of such increased competition are also likely to be the largest in small countries where each market segment has traditionally been dominated by only a few domestic companies.
However, in order to reap the full benefits of the single currency, it is important to avoid any tendencies towards nationalistic or European protectionism. In order to be successful at the international level, it is essential to be exposed to competition and influences from outside. At the same time, structural reforms are required to improve the working of the euro area economies. These are lessons that Finland - and some other small countries in Europe - learned the hard way in the early 1990's, possibly leading to a greater acceptance for necessary structural measures in these countries than in some of the larger countries. Remembering these lessons for the future may become an important contribution of the smaller countries to the improved functioning of the euro area economy.
(1) The highest decision-making body of the Eurosystem, the Governing Council, has 17 members: the governors of the 11 national central banks and the six members of the Executive Board of the European Central Bank. The decisions on the key monetary policy interest rates are made on the basis of one person, one vote. The responsibility of the Executive Board is to implement these decisions. Actual transactions with counterparties are executed in a decentralised manner by the national central banks, according to the instructions of the Executive Board.
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