The year 2000 was forecast to be good for the euro. It was hoped that it would recover from 1999 blues, the first year of its birth. The original benefits of integration, ie, more efficient allocation of capital and rationalisation of businesses were to have dripped down into a stronger economy and the gradually improving cyclical growth environment in the euro area to have eventually reflected in a stronger currency. On the other hand, after starting 2000 strongly, it has again started falling to record lows.

Part of the reason can be traced to the market's lack of conviction with European Central Bank's (ECB) strategy. Earlier, there was also a perception that Euro-zone politicians and central bankers were at loggerheads. Bundesbank president Ernst Welteke too believes that ``in respect of a new currency, it is a question of people's confidence and a psychological problem.''

ECB officers have also shown no urgency to talk up the Euro or engineer any support for it. With official inaction, intervention is not perceived to be a threat. While the stated policy is that exchange rate is important, many of ECB's policymakers, led by ECB president Duisenberg are happy to ignore the exchange rate unless it produces clear signs of inflationary pressure.

In fact, the current mix of a low exchange rate and low real interest rates are giving an unnecessarily powerful stimulus to growth in the Euro-area.Recent data highlights the continued pick-up in the economy. With GDP growth in the second half of 1999 expected to improve sharply to an annualised 4 per cent, forecasts for 2000 have also been revised upwards to 3.5 per cent.

There has been an improvement in industrial production (1.2 per cent quarter on quarter growth). Both consumer spending and exports growth are reinforcing each other and are capable of exceeding expectations. The strength of the upswing gives rise to inflationary concerns.

Monetary conditions are at their loosest in many years (M3 grew 6.4 per cent annually in December). A fairly aggressive rate tightening by the ECB is expected. With the current Euro weakness, this may get accelerated to as soon as next week. In any case, the benchmark refinancing rate is predicted to be hiked by 50 bps to 3.5 per cent by April and probably to 4.5 per cent by first quarter of 2001. Unfortunately, despite the good picture emerging from the Euro-area, the US economy (now in its 107th month of expansion) continues to overshadow.

Friday's release of the US GDP and Employment Cost data has created nervousness. Fourth-quarter GDP growth at a 5.8 per cent annual rate was the strongest this year after the 5.9 per cent seen in fourth quarter of 1998. While the annual growth rates have been showing a steady decline from 4.5 per cent in 1997 to 4.3 per cent in 1998 and 4 per cent in the latest year, there is still a big divergence in growth rates vis a vis other OECD economies. With some inflationary pressures also building up (as visible by the 2 per cent gain in GDP deflator), the Federal Reserve too will go in for aggressive rate hikes. These may neutralise the impact of the ECB's action.

The trend against the yen is another one to watch. The down moves have been significant. At the current yen 103 levels, the euro has lost 6 yen over the past two weeks and is near its record 102.05 low touched on December 6. The yen offers direct competition to investors looking for economies with a recovery story. Both face some comparable economic conditions.

They suffer from deep-seated structural problems and despite an improvement in recent growth performances, have wobbly economies. Also many Japanese institutions are long Euro and the Euro-Yen FX flows have a significant impact on the markets. The current trend remains negative. With the Euro-zone finance ministers meeting on Monday and the US Federal Reserve expected to increase interest rates on Wednesday, there are more than a few reasons to be cautious. The campaign finance scandal swirling around ex-chancellor Kohl is also causing uncertainty. As long euro stop losses are triggered, they may take the currency to even lower levels before recovery begins.

(The author is head of treasury marketing of a foreign bank. The views expressed here are his own.)