The euro is undervalued and should appreciate sharply next year, according to economic forecasts. The Central Bank and the Economic and Social Research Institute are bullish on the prospects for the European currency, which will become legal tender on January 1st.

Central Bank assistant director general, Dr Michael Casey, suggests the euro would improve in value against the dollar, with the ESRI forecasting that it could even move to parity with the US currency next year. The strength of the euro will be helped by the large deficit on the current account of the US balance of payments, the differential between US and European interest rates and narrowing of growth prospects between the US and euro-zone economies.

The ESRI has warned, however, that a stronger euro could add to the difficulties of many Irish businesses, particularly those which are reliant on exports to the UK. These businesses also tend to be among the most labour-intensive, which could trigger further job losses.

Economic activity has slowed dramatically in the euro area, bringing growth rates down to 0.1 of a percentage point in the second and third quarters. This weak pattern is expected to have continued in the fourth quarter, according to the Central Bank. The Bank also noted a surge in consumption in the run-up to the introduction of the euro as consumers sought to spend surplus cash. It suggests that the circulation of the euro from January 1st will also help to enhance the currency's fortunes.

According to Central Bank figures, the amount of notes and coins in circulation in the Irish economy rose sharply throughout 2001, due mainly to people spending funds that had been held in cash. It recorded a 15 per cent rise in circulation of notes in January, with successive increases each month. The Bank does not believe all of this is due to the release of so-called "mattress money", but that it also reflects increased disposable incomes.