The euro & you

The international role of the euro

The single currency is designed to promote growth and economic stability in  the economies of the participating countries.  A side effect has been the emergence of the euro as a new international currency, "one which has important benefits for our external economic partners," Economic and Monetary Affairs Commissioner, Pedro Solbes, points out.  "For them, it means reduced volatility in monetary relations and improved trade and investment conditions."

One of the most immediate signs that the euro has been accepted by the world at large is its importance in international bond markets.  This became immediately evident at the beginning of 1999 when for a time the euro overtook the dollar as the most widely chosen currency for new bond issues.   The situation has stabilised since then, but the euro has remained popular.  In 2001, 36.5% of all new issues - so-called gross issuance - were in euro according to the Bank for International Settlements, compared to 49.1% in dollars.  In 2002, the corresponding figures were 38.4% and 46.9%.

Moreover, while the dollar's market share of new has been stagnant at best, the euro's has increased sharply.  This has reversed the situation in the years prior to launch of the euro.  At that time, the euro's predecessor currencies were struggling to hold their own in competition with all other currencies.  Meanwhile, the dollar was gaining ground at the expense of the yen.  Since the launch of the euro, the US dollar has struggled to maintain its market share.  The euro, on the other hand, has advanced in leaps and bounds. 

This was initially largely at the expense of the yen, but figures from the Bank for International Settlements (BIS) show that the euro has not only continued to make strides in Europe, but has also strengthened its position in the rest of the world.  In 2002, of net issuance, i.e. gross issuance less the amount of issues which have been redeemed, outside the euro area 14.9% was in euro, compared to only 11.1% in 2001.  In the United States, the euro increased its share of net issuance from 10.6% in 2001 to 11.3% in 2002.  In the rest of the world outside the euro area, the figures were 14.1% and 22.7%, reflecting the growing interest in the euro in markets such as Asia.  Overall, the euro's share of total net issuance worldwide went from 44.3% in 2001 to 51.2% in 2002.

The main attraction of bonds issued in euro is that there is now a single hungry market of savers in the euro area looking for low- to medium-risk investments in their own currency.  For the issuers, it costs much less to reach this market now than when it was fragmented because they can issue in one currency for a large market.  In addition, it is much easier to trade the bonds once they have been issued because there are more potential buyers and sellers.  This makes the market more competitive.  At the same time, the euro offers an opportunity to diversify sources of funding away from the US dollar. This combination has proved very attractive, in particular, to multinational corporations and mortgage agencies, such as 'Freddie Mac', the Federal Home Loan Mortgage Corporation in the United States.

As a rule of thumb, when issuers from outside the euro area see European investors as their primary target, they denominate the issue in euro.  If their market is global (including Europe), then the dollar is still the currency of choice. This is something that is changing slowly but steadily.

As a transaction currency, the euro has started by building up its position on its domestic markets and by making its mark on its immediate neighbours. "The international role of the euro has a strong regional focus," the European Central Bank pointed out in a review of the international role of the euro late last year.

For example, countries with strong institutional or trade links with the euro area are generally more likely to use the euro in their financial markets, as a peg or anchor for their exchange rates, for invoicing or as a parallel currency. The Lebanon, Egypt and Israel have all borrowed euro on international financial markets.  The euro represents a significant share of trading in bonds and over-the-counter derivatives in the London financial markets, for example, but does not play the same role in New York or Far Eastern financial markets.

Another straw in the wind is a small but significant shift from the dollar into euro in bank deposits in the Middle East, Africa and emerging Europe.  The Bank for International Settlements pointed out this year that Russian banks have been significantly increasing their euro-denominated deposits with bank in developed Europe.  Deposit outside Russia have been on an upward trend since the end of 1998 "and have continued to migrate from banks in the United States to banks resident in Europe."

The euro also circulates as a parallel currency in central and south-eastern Europe, parts of the Balkans and around the Mediterranean.  This is logical.  The German mark and to a lesser extent other former euro-area currencies like the Austrian schilling and the French franc had long circulated in these regions.  It was not self-evident in 2001, however, that when the time came to exchange this money, the euro would be the currency of choice.  The euro was weakening against the dollar and there was speculation that the dollar would be regarded as a better  'safe haven' currency. 

What exactly happened is hard to establish because no one knows how much emerged from under the mattresses in these countries and entered the banking system for the first time, but interest in the euro was certainly strong.   Euro-denominated deposits rose by more than €13.5 billion (around 40%) in 2001 and in many countries went on increasing strongly in 2002.  The increases were particularly marked in Croatia, Hungary, Poland, Turkey and Israel.  Demand for euro banknotes was also strong and the shift into domestic or other currencies appears to have been limited according to the European Central Bank.

There was further proof that the euro had 'arrived' as an international currency during the Iraq conflict.  The strengthening of the euro was clearly related to a view that the euro is now a 'safe haven' currency.

The ultimate accolade for a currency is to be a regular component of the world's foreign currency reserves.  This is an exclusive club.  Four members - the dollar, the euro, the yen and the pound sterling - account for 90% of the world's reserves.  68% of all reserves were held in dollars at end-2001, a figure unchanged for three years.  13% were in euro. Since its launch, the euro has held pretty much the same position, one not significantly different from the combined share of euro-area currencies in international reserves before 1999.  That in itself was a creditable performance because the value of the euro weakened in the first couple of year's of existence.

Nevertheless, when the figures for 2002 become available in September this year, they will be eagerly scanned by many in the euro-area for signs that the euro is entrenching its position in this club.

this page updated January 11, 2008