FROM THE ARCHIVES: January 6, 2003

Stronger Euro Stings Exporters,
Raising the Prospect of Rate Cut


FRANKFURT -- The strengthening euro is beginning to pinch European exporters and it is increasing expectations that the European Central Bank may cut interest rates later this year.

In recent weeks, international companies ranging from beer brewers to electronics manufacturers have warned that the appreciating currency was chipping away at foreign sales and profits. All other factors equal, a rising euro makes European goods more expensive overseas, and therefore less competitive, or yields exporters smaller earnings when they convert foreign profits into euros. The cries are loudest in Germany and Ireland, the two euro-zone countries most reliant on exports.

[chart]Last week, the euro briefly rose above $1.05 to a three-year high. It traded at $1.0417 late Friday in New York, making for a 16% rise over the past year against the dollar and a 6% rise against a basket of major currencies used by the ECB.

The common currency, founded four years ago, was designed to help shield the 12-nation euro zone from outside shocks by creating a large, closed economy. But Europe is still more sensitive to an appreciation in its exchange rate compared with the U.S., partly because the European economy is nearly twice as reliant upon trade. The ECB estimates that a 5% increase in the euro sustained for a year can knock as much as 0.9 percentage point off annual growth in gross domestic product, seven times as much as for a similar increase in the dollar for the U.S.

The euro was weak for the first several years of its existence, and European officials fought the steady decline by talking it up and by intervening in the foreign-exchange markets. Officials still back a strong euro , but the appreciation is coming at a time when the stagnant European economy could use a boost from the export sector to jump-start the domestic business cycle.

In the eyes of the ECB, the level of demand for European goods in Japan and the U.S. will determine the pace of an expected economic recovery this year. Right now, ECB officials aren't ruling out another cut in interest rates after the bank slashed them a half-point in December. The bank isn't, however, expected to cut as soon as its meeting Thursday. And an ECB shadow council of academics and bank economists -- sponsored by the German business daily Handelsblatt and The Wall Street Journal Europe -- also voted to hold the key rate of 2.75% constant this month.

For Germany, which is the euro zone's largest economy, sales to the U.S. dropped 15% during the first 10 months of 2002, compared with a 9% increase in 2001 and double-digit rises during the previous three years. Some 40% of manufactured goods are exported. "There are firms that are on the pain threshold right now," said Axel Nitschke, chief economist with the German Chamber of Commerce for Industry and Trade.

One firm feeling the pinch is Siemens AG. The electronics company generates about 80% of its sales outside Germany. In the fiscal year ended Sept. 30, sales slipped 3% to 84 billion ($87 billion) and new orders declined 7% to 86.2 billion -- partly because of the foreign-exchange fluctuation.

Interbrew NV, the Belgian company that brews Beck's and Stella Artois, last month warned that 2002 earnings could take a hit because of the strong euro . Reed Elsevier PLC, the Anglo-Dutch publisher of Variety, also said a strong euro threatened earnings per share this year.

Elsewhere, the Ireland's central bank said in a recent report that "a significant and sustained appreciation of the euro would impinge on the competitiveness of the economy."

Write to G. Thomas Sims at