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. Last Updated: 07/27/2016

Low Euro Credibility Troubles Bundesbank

FRANKFURT, Germany -- Germany's Bundesbank on Wednesday launched a broadside in defense of the European single currency, warning that its exchange rate had become so misaligned that its credibility was at stake.

In its monthly report for May, the German central bank said the slide of the euro in 1999, especially in the first half of the year, was arguably consistent with the euro zone's growth and interest rate outlook at that time, but no longer. "All relevant yardsticks for judging exchange rates point to an overreaction" in foreign exchange markets, it said.

For the credibility of the fledgling currency, "such misvaluations are not good."

The Bundesbank cited an internal study, as well as analyses by the International Monetary Fund and the Organization for Economic Cooperation and Development, which attempt to quantify the euro's misalignment.

Bundesbank president Ernst Welteke in a speech Monday said the single currency was undervalued by 20 percent to 30 percent, but the euro showed little reaction to the comment at that time. The euro strengthened Tuesday, however.

Foreign exchange markets during the first quarter of 2000 "appear to have become driven by an internal dynamic that has more and more lost touch with fundamental factors," the report said.

The Bundesbank worried openly that the euro's slide on the foreign exchange markets was damaging the currency's credibility.

The euro has fallen some 7 percent this year against a weighted average of the euro zone's 13 major trading partners, after falling almost 14 percent in 1999, the bank noted.

"The Deutsche mark in its time also saw examples of such overshooting of exchange rates. For the reputation of the young currency however, such misvaluations are not good," the Bundesbank said.

The short-term competitive advantages to exporters of the euro's fall should also not be overestimated, the Bundesbank warned. Exports account for only 13 percent of the euro zone's gross domestic product and most of the recent export upswing has been due to the recovery of emerging markets and world trade.

"The temporary competitive advantages from depreciation in any case could not make up for any damage to the credibility of the currency," the Bundesbank said.

There has been enough movement towards implementing structural reforms "that a more positive evaluation of the euro zone's future prospects would be justified," it added.

In an unusually upbeat tone, the central bank highlighted a list of such structural accomplishments - progress in budget consolidation and the political will to stay the course, tax reform in large euro zone countries, the opening and liberalization of goods and service markets, increased flexibility in labor markets and signs of an employment-friendly wages policy.