The initial goal for the establishment of the European Union, which has managed to survive until today, is the creation of a united and integrated Europe. Until the end of 2006 the EU consisted of 25 countries. This number has increased to 27 in 2007 with the accession of Bulgaria and Romania to the European family.
Twelve of the member states share the Euro as their common currency. They are: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxemburg, the Netherlands, Portugal and Spain. They make up the European Monetary Union (EMU).
These twelve countries also are subject to the monetary policy that is established by the ECB (European Central Bank). Combined together in the EMU, these countries constitute the second economic power in the world.
Convergence Criteria for EMU Membership
In order to become part of the EMU the applying member state should meet a number of criteria. They were established in the Maastricht Treaty of 1992. These criteria are also known as the convergence criteria or the Maastricht criteria.
- The applying state should keep an inflation rate of no more than 1.5% above the average. This average is calculated on the basis of the 12-month average of the three best performing countries before the date at which assessment is made.
- Additionally, the long-term interest rate of the applying for EMU membership country should not be greater than 2% of the average of these best performing members.
- Another criterion concerns the exchange rate fluctuations. These should be within the normal margins of the ERM (exchange rate mechanism) for not less than two years.
- The general government debt/GDP ratio should not exceed 60%. Exceptions are made if the country shows that this ratio is consistently decreasing.
When these criteria are met the applying country can become part of the EMU.
Economic Significance of the EMU
The EMU has attracted many investors since it enjoys very well-developed fixed income, equity and futures markets. However, this has not always been the case, since in the past it was less attractive to FDI. This is so since the US have presented assets that offer more solid return rates.
However, the popularity of these US assets has declined recently thanks to the increasing EMU interest rates.
Trade is of great importance to the economies of the members of the EMU, since the latter is characterized as being capital flow and trade oriented economy. The EMU has neither a significant trade deficit nor a surplus.
The EMU plays a major role on the international trade arena since it executes a large number of trades with the rest of the world. The establishment of the EU has as its major purpose international trade dominance. This is greatly facilitated since many countries are grouped together and act as one unit when trade issues are concerned. Thus, they manage to negotiate as one entity with the US – EU’s biggest trade partner.
Another characteristic of the EMU economy is its service orientation. This sector accounts for the biggest percentage of total GDP. Innovation, research and development, design and marketing are the major activities on which EU companies focus, while they tend to outsource actual production to regions with low cost of labor, such as Asia.
The importance of the Euro as a reserve currency is stressed by the growing influence of the EU. Large amounts of reserve currencies in needed in order to alleviate exchange risks and transaction costs.
Before the Euro entered the international trade scene, the USD, GBP and the Japanese Yen represented the basic currencies in which international transactions were executed. This resulted in the USD being the major currency in which reserves were held.
However, the introduction of the Euro changed this by making it one of the currencies in which many countries hold their reserves.
Euro Indicators to Watch
When studying the movements in the value of the Euro you should analyze several indicators. When doing the analysis, you should have in mind that the EMU consists of 12 countries and any change in the economic and political conditions in these countries can result in a change in the EUR value.
Germany, France and Italy represent the largest states within the EMU. Thus, their economic and political conditions should be closely watched because a change in them may result in a significant movement in the Euro.
The indicators you should pay special attention to are:
Money Supply (M3)
This measurement includes money supply tools ranging from notes and coins to the deposits placed in banks. M3 is regarded as a key gauge for inflation levels by the ECB.
In order to avoid any distortions of the information extracted from the aggregate, the growth rate is examined every 3 months by using the moving average. Since the ECB’s approach toward setting targets is quite flexible, significant room for interpretations and maneuvering is left. A reference value is set. If the numbers diverge from this value the EBC doesn’t impose any bands on the growth of the M3.
The Eurostat issues a preliminary GDP measure. This is done when enough data is collected from member states. Italy is not part of the preliminary GDP value and its number is added to the final one. The yearly number for EMU-11 and EU-27 is easily calculated since it represents the sum of national GDP. However, the quarterly estimate is more difficult to get since not all of the countries report such.
Individual Member State Budget Deficit
Member states should meet a target level of budget deficit. The forex market participants closely view the ability of the countries to meet these limits.
Harmonized Index of Consumer Prices (HICP)
The EU law requires that international comparison is made. The tool used for this purpose is the HICP, which is published by the Eurostat. The MUICP has been introduced to measure the index for the EMU-11 area. In order to calculate the value of this index data on the prices is received from each of the states’ statistical agencies. The HICP consists of 100 sub-indexes are used in the calculations as weighted averages.
German Economic Indicators
The Labor Office issues a report on the number of unemployed and the changes that have occurred during the past month. The data comes both in a seasonally adjusted and non-seasonally adjusted form. Information on the vacancies, the unemployment rate and the short-shifted working arrangements is issued by the National Statistical Institute.
Shortly after the FLO is released, the seasonally adjusted unemployment rate is provided by the Bundesbank. However, an approximation of the data to be released is known a day before the actual release due to a leak made by a trade-union source.
The official figures are usually reflected when the actual figure is reported by the Reuters as given by “Source”.
Before the actual release is done, many rumors go around which carry significantly incorrect information. Thus, you should approach such unofficial announcements with great caution.
The seasonally adjusted data from the following categories is provided:
- Manufacturing – this aggregate includes four groups of products
- basic and producer goods
- consumer durables
- consumer non-durables
- capital goods
The forex market is generally interested in the seasonally adjusted monthly numbers. In order to avoid overemphasizing aberrations for one month, the Finance Ministry tends to stress on comparison over two months. When the full sample is available the release is reexamined, since it is initially based on a smaller sample.
Since Germany represents the largest economy in Europe, it is used as a measure toward which the overall economic conditions in Europe are evaluated.
Thus, the IFO institute makes a survey of 7,000 German firms, which are asked to make an evaluation of their short-term business plans and the overall business climate in the country.
The results of the survey include information on the current business conditions and the expectations on the future business development. The usefulness of the measure is increased when it is compared to past data.