The euro: the birth of a new currency
Presentation by Ms Sirkka Hämäläinen, Member of the Executive Board of the European Central Bank, at the meeting of the Institut International d'Etudes Bancaires on 21 May 1999 in Helsinki
It is a great pleasure and honour for me to have been invited here today to say a few words about the birth of the new European currency - the euro.
On 1 January 1999, eleven European countries took a historical step forwards by entering Stage Three of Economic and Monetary Union. Thereby, the national currencies of these eleven countries became denominations of a single currency. At the same time, the "Eurosystem" (which is composed of the European Central Bank (ECB) and the eleven national central banks of the participating Member States) assumed responsibility for the monetary policy of the euro area.
In hindsight, I think we can say that the technical change over to the euro was a tremendous success. Taking into account the monumental task of more or less simultaneously implementing changes in thousands of computer programs and operational procedures throughout the financial markets, it is astonishing that we experienced only minor teething problems; and these problems seem to have been corrected in the meantime. The successful technical launch of the euro was made possible thanks to the careful preparations of the project. It also showed that all participants (i.e. the ECB, the national central banks, public authorities and, above all, banks and other financial institutions) were committed to the project and that they carried out their preparations in a professional manner.
However, the changeover to the euro has not yet been completed. The euro still exists only in non-tangible form, i.e. in the form of book entries in information systems. The absence of euro coins and banknotes may have implied that the introduction of the new currency was perceived by most people as a rather abstract event.
The national banknotes and coins will remain in circulation until the euro banknotes and coins are introduced in 2002. This "second" changeover will likewise require substantial preparations. Apart from the one-off large-scale printing of banknotes and minting of coins, it will also require important changes for the handling of cash in the retail sector, e.g. the adaptation of teller and vending machines. I am convinced that all the parties involved will execute this "second" changeover just as professionally as the "first" changeover at the beginning of this year.
Clearly, the launch of the euro was a truly historical event, not only in view of the complexity of the task and its careful preparations, but mainly in that it would have far-reaching economic and political consequences for the participating countries and for the international monetary system as a whole. Most of these consequences are of a gradual and long-term nature.
The euro will have important consequences at many different levels:
first, we should not forget that the idea of introducing a single currency was originally motivated by the overall political arguments that an increased integration of the European countries would reduce the risk of war and crises on the continent. Through the establishment of common institutions, political conflicts could be avoided or, at least, resolved through discussion and compromise, rather than by resorting to force. Hence, at a general level, the introduction of a single currency in the euro area is an important symbol for political and social integration in Europe which should serve as a catalyst for further co-ordination and integration also in other policy areas;
second, on a macroeconomic level, a single monetary policy in the euro area which is firmly geared towards price stability will enhance political and economic stability, not only in the euro area, but also in a global context;
third, on a microeconomic level, the use of the same currency in the euro area will increase cross-border competition and market integration, thereby improving the efficiency of the markets for goods, services and capital in the participating countries. This should lead to reduced transactions costs, improved price transparency and lower price pressures.
In view of these long-term effects, I think that it would be unfair to judge the success of the euro only on the basis of the economic and financial developments during the first five months of the new currency's life - particularly to the extent that these short-term developments reflect effects of economic trends and political events outside the euro area.
Nevertheless, the experience of the first five months of the new currency's life gives some indications of the international importance of the euro and its implications for the financial markets in the euro area as well as in a global perspective. I would like to share with you some of these experiences gained in the five months since the euro was borne, seen from a banking perspective.
The euro - a new player in the foreign exchange markets
The most obvious consequences of the introduction of the euro were to be seen in the functioning of the foreign exchange markets. The mere fact that eleven European currencies, some of which were among the most actively traded currencies world-wide, disappeared and were replaced by the euro as a major international currency had a fundamental impact on the turnover and focus of attention in the global foreign exchange markets.
The Bank for International Settlement (BIS) recently presented a survey of the foreign exchange and derivatives markets in 1998. This survey shows that, in the last few years, the US dollar increased its importance in the foreign exchange markets. In 1998, the US dollar was involved on one of the sides in 88% of all foreign exchange transactions, compared with 45% for the currencies that were replaced by the euro.
It is interesting to note that, compared with the previous survey carried out in 1995, the share of transactions carried out in the currencies which were replaced by the euro has fallen considerably. It appears that market participants, even before the euro was launched, considered the various constituent currencies as close substitutes.
So far, there are no reliable statistics available on the development of the foreign exchange markets since the introduction of the euro. However, early indications based on information from market participants seem to indicate that the euro's share in international foreign exchange transactions is currently indeed lower than the aggregate share of the constituent currencies was in 1998.
Nevertheless, euro/US dollar trading established itself from the very outset as one of the most active and liquid segments of the foreign exchange market, providing a variety of instruments and large hedging possibilities.
The development of euro/yen trading, by contrast, has so far been surprisingly slow. As a matter of fact, this holds true of trading in euro against Asian currencies in general. It is as yet too early to assess the reasons behind this rather slow development of euro/yen trading, although there seems to be some caution among investors and traders in the Asian region to use the euro. This caution could be related to the generally relatively weak performance of the Asian economies, and it may be underpinned by the fact that the euro is a new currency with no historic data to conduct analysis and to base investment decisions on. Here, the Eurosystem will have to continue to play an important role by informing and communicating with actors in the international financial markets in order to increase the knowledge and understanding of the objectives of the Eurosystem and to explain the functioning of the policy measures and instruments at hand.
This notwithstanding, I think that it is indisputable that the euro is likely to further strengthen its position as one the most important currencies in the foreign exchange market. The sheer size of the euro area economy, which is comparable to the US economy, is an important factor which should ensure this status. The Eurosystem's firm commitment to price stability should also contribute to the long-term stability and credibility of the euro, thereby promoting its attractiveness as a trading and investment currency. In the longer run, the further development and integration of the euro area financial markets will also contribute generally to enhancing the international attractiveness of the euro.
Integrated money market in the euro area
One segment of the euro area financial markets in which we have already seen rapid changes following the introduction of the euro has been the money market. Before the euro was borne, we wondered how rapidly and smoothly eleven separate money markets would integrate. Traditionally, the national money markets each had their own market participants, different dealing procedures and settlement structures, segmented credit lines, different languages; even market conventions, such as the method for calculating interest, the opening hours and public holidays, used to differ across the national money markets.
From the Eurosystem's perspective, it was considered important that an integrated euro area money market was established relatively soon after the introduction of the euro since this would be a pre-condition to ensure that cross-border arbitrage eliminates interest differentials across countries.
In reality, the national money markets turned into an almost fully integrated euro area-wide money market within one or two weeks - even faster than we had expected. The experience of the euro area money market shows that, since the introduction of the euro, the daily dispersion of country averages of overnight rates (as measured by the EONIA (European Overnight Index Average)) has stabilised at around 2 to 3 basis points. In addition, it shows that there is no systematic interest rate difference between the rates offered by banks established in different financial markets. We can therefore conclude that we have achieved a euro area-wide money market which is sufficiently integrated to ensure a single monetary policy stance throughout the euro area.
In order to achieve an integrated money market, the establishment of new payments systems structures was instrumental. Here, the TARGET system developed by the Eurosystem plays an important role. This system links all the large-value national payment systems in the EU. It is interesting to note that this system is currently handling considerably more cross-border payments than initially anticipated.
Recent developments on the European capital markets
Turning to the longer end of the yield curve, the cross-border integration of bond markets in the euro area is progressing at a slower pace, as is also true of equities and derivatives markets. This notwithstanding, we are experiencing important developments also in these segments of the financial markets, part of which is related to the introduction of the euro.
The capital markets in Europe have traditionally been highly segmented. This segmentation was the result of the use of different currencies as well as of differing regulations, taxes, market practices, etc. Thanks to the introduction of the euro, market participants increasingly perceive similar instruments traded in the different national markets to be close substitutes. This holds particularly true of bonds issued by the euro area governments, where the establishment of common benchmarks, the narrowing of yield spreads and increased market liquidity seem to indicate that a high degree of cross-border substitutability has already been achieved.
The fact that euro area financial instruments are increasingly considered to be close substitutes increases the competitive pressures for the national markets to attract issuers and investors wishing to benefit from increased cross-border competition and lower transaction costs. In this context, we have recently experienced several initiatives aimed at creating capital markets across national borders, such as the plans to establish pan-European stock exchanges.
Initiatives towards an increased integration of capital markets are welcome since they may provide for a wider range of financial instruments on offer, at a lower cost, than is currently the case in the national markets. This could lead to a positive circle in which the increased issuance of instruments denominated in euro will draw the attention of international investors to the euro area capital markets, thereby again making the euro an increasingly attractive currency for private as well as public issuers.
In fact, the experience from the first months of the life of the euro seems to indicate that such a positive development may already be at hand. In the first quarter of 1999, bonds denominated in euro accounted for around 50% of the bonds issued internationally. This share is considerably higher than the traditional aggregate share for the bonds denominated in the constituent currencies, which was in the range of 20% to 30% in recent years. We have also seen a considerable increase in the average size of the bond issues denominated in euro, as compared with those of bonds denominated in the former currencies, which may indicate that the trade in euro denominated issues is likely to become increasingly liquid.
Despite the recent developments in the euro area capital markets, there is still plenty of scope for further securitisation in the euro area. For example, the amount of private bonds is still minuscule, compared with the United States. Private companies established in the euro area are still heavily dependant on financing through the banking system. However, I would expect that the increased efficiency of the euro area capital market will lead to a swift increase in the number of companies preferring to raise funds directly on the market.
Implications for the European banking structure
In this context, I would like to say a few words on how the introduction of the euro may underpin the reshaping of the European banking sector - although this is a subject you know far more about than I do. Traditionally, the banking sector of the euro area countries has lagged behind the banks of the United States and the United Kingdom in the provision of advanced and international financial services.
So far, the European banking industry has remained segmented into rather small national markets. The introduction of the euro seems to have given momentum to cross-border integration in the European banking sector, as a result of the disappearance of the certain barriers implied by national currencies. For several years, large-scale mergers and acquisitions have taken place in Europe, but it was only very recently that we have started to see such deals to take place across national borders.
I very much welcome this trend towards an expansion beyond national borders, since the establishment of truly pan-European - and global - banking groups will be instrumental in the efforts to enhance competition in the provision of financial services. However, increased cross-border banking activities will require close co-operation on the part of the national authorities responsible for prudential supervision and for monitoring market competitiveness. Here, I should like to express some concerns about any tendencies of national authorities to try to favour the preservation of "national" banking structures at the cost of postponing the development of a competitive and efficient pan-European banking structure.
The increased scope for securitisation in Europe will put further pressure on the banking sector to move away from traditional bank lending towards more specialised financial services. We have only seen the beginning of a major structural reshaping of the European banking sector. At present, there are almost 10,000 credit institutions in the euro area. Large benefits from economies of scale are to be gained from consolidation in the European banking sector, whereby the number of universal banks may be significantly reduced. When a business sector faces the need for major structural reshaping, it is important to see the challenges and opportunities ahead, rather than applying a defensive and protectionist approach. However, I am convinced that decision-makers in the banking sector are well aware of the changing environment - I just hope that they will be able also react fast enough.
I should like to conclude by underlining once more that, although it is too early to make a firm assessment of the long-term success of the euro and its role in the international monetary system, it is beyond any doubt that the euro will further strengthen its role as one of the world's leading currencies.
In addition to its economic impact, Economic and Monetary Union has and will continue to have an immense psychological and political impact at the global level. Europe may have been perceived - especially from outside - as excessively inward-looking throughout this period. But the construction of strong institutions for a common Europe has been and will continue to be necessary before Europe will be ready to assume its share of the responsibility for and play its role in the resolution of global problems.
The sheer size of the euro area in the world economy as well as the institutional set up of the Eurosystem, ensuring a firm commitment to price stability, are important factors determining the international role of the euro. However, the long-term success of the euro also depends crucially on the determination of governments to maintain fiscal discipline and undertake necessary structural reforms. It also depends on the ability of the private sector, and not least the financial services industry, to respond to the demands of the new environment by improving competitiveness and foster innovation. In this respect, the experience gained after the first five months of the new currency is very encouraging. The successful technical implementation of the euro, the rapid establishment of a fully integrated money market in the euro area and the on-going developments in the euro area capital markets seem to indicate a high degree of preparedness by the banking system to meet the challenges of the new environment.