Any meaningful analysis of the pound's status has been quite difficult over much of the past year, with revaluation speculation tending to ebb and flow in a manner akin to the winds and the electricity supply over the Christmas period. The latest episode in the saga has seen the currency fall by four pence against sterling, by 11 cents against the dollar and by 13 pfennigs against the deutschmark during a four-week period.
This decline in the value of the currency has put it back very firmly in the eyes of the international financial media with the level of coverage a little bit reminiscent of its celebrity status back in 1992.
This is not a particularly helpful situation, with just four months to go before the crucial single currency decisions are made.
It is now high time that the situation was clarified by the Minister for Finance so that the Republic's beleaguered trading sector and the Central Bank might plan with some degree of certainty.
The decline in the pound has not resulted from massive selling of the currency, but rather by a consistent level of relatively modest selling on an almost daily basis.
Somewhat surprisingly, as the currency fell to new lows against the dollar and sterling in particular, buyers failed to emerge and consequently the decline was exaggerated. The selling - and the lack of buying - have been driven by a number of forces. Domestic companies and international investors have finally concluded that after so many months of speculation, an upward adjustment to the pound's ERM central parity is highly unlikely and that the currency will ultimately lock in to the euro at DM2.4110. However, there is also an element of confusion, uncertainty and perhaps even frustration driving the selling, because the markets do not take kindly to an apparent lack of a clear exchange rate policy.
Some commentators were surprised by the absence of any reference to the currency in last week's Central Bank monetary policy statement.
However, it is not the Central Bank's job to enunciate exchange rate policy; rather its job is to carry out the exchange rate policy which is determined by the Minister for Finance, in this case, Mr McCreevy.
Obviously, the policy dictated by the Minister should be consistent with the anti-inflation goal of the monetary authorities. What we now await is a clear signal from the Minister as to what exactly the policy is. This requirement is most probably desired by two distinct groupings. On the one hand, the Central Bank would be in a much more comfortable position to quickly pursue the interest rate policy which is implicit in European Monetary Union (EMU) if it had some certainty in regard to the exchange rate. However, even more importantly, the European political and financial firmament is likely to be quite anxious to have the Irish situation clarified as soon as possible.
At this stage most of the issues have been sorted out ahead of May, with the exception of the pound. The other 10 EMU currencies have all been trading very close to their ERM central parities for a considerable period of time, but the Irish currency has been very conspicuous at the top of the ERM grid. There are enough risks and problems to be overcome on the path to EMU without a tiny currency like the Irish one potentially upsetting the apple cart.
This is also true in relation to interest rates. Convergence of short-term interest rates is now at an advanced stage across Europe, with even the so-called "garlic belt" countries being quite aggressive in terms of their interest rate policy. The Spanish and the Italians both delivered substantial rate cuts in December.
Irish official interest rates on the other hand have not been adjusted since last May, and even then it was a rate increase rather than a cut. It is now high time that Irish rates started to fall because a gradual decline beginning immediately would be much preferable to a sudden sharp fall in May. It is not difficult to figure out why the guardians of price stability in Dame Street might be reticent about allowing rates fall sooner rather than later, but that is the reality of EMU. If one enlists, one must march. With Ireland firmly committed to membership from the beginning, the appropriateness of core European interest rate levels to Ireland's situation is not relevant.
A Dutch bank based in London commented last week that Ireland's high level of interest rates and strong economy make the country a less appropriate EMU member than any of the others. It is very important not to be conspicuous.
The bottom line is that the Minister now needs to give a clear signal about his exchange rate intentions. Obviously he cannot announce that Ireland will be entering EMU at its existing or at a new ERM central parity, because it has not yet been formally announced that central parities will be used.
While most people suspect that this will be case, the decision is not likely to be made public until May.
However, the Minister can formally announce that he does not intend adjusting the pound's central parity. He will be presented with an ideal opportunity of doing this at the upcoming Ecofin meeting on January 19th, and indeed it is quite possible that his European counterparts may put pressure on him to do just that. Once that is done, the Central Bank would be in a position to allow interest rates to fall gradually and Ireland would shed its potentially dangerous outsider status.
Jim Power is chief economist at Bank of Ireland Group Treasury. The views expressed here are personal.
