Initiative for Peace in Kosovo May Provide Support for Euro

Okay, so the euro doesn't look like it will displace the U.S. dollar as the world's reserve currency anytime soon.

But for the first time in what seemed to be quite a long while, euro supporters last week could cheer that the new currency had posted modest gains against the dollar. The euro, which has been losing value since it was introduced Jan. 1, got a boost as foreign ministers from the

Group of Eight

nations reached agreement on steps toward a peace settlement for Kosovo.

Unfortunately just as the momentum behind the agreement was starting to build and

NATO

had Russian support for the plan, allied planes Friday night mistakenly bombed the Chinese embassy in Belgrade, the Yugoslav capital. While NATO officials apologized, it was unclear if the blunder would derail the G8 initiative. In any event, the incident underscored how heavily the conflict in the Balkans weighs upon the euro and European equity markets.

Economists have been predicting since last fall that the euro would strengthen against the dollar throughout 1999. But in the first four months of the year, exactly the opposite has happened. The euro, which hit its lowest level of $1.055 on April 30, finally turned itself around and clambered up to $1.076 on Friday as the seven-point plan for an armed U.N. peacekeeping force for Kosovo was agreed upon.

However, even if a cease-fire for Kosovo can be achieved, another factor might very well put a damper on any "peace" rally that the euro and Continent's equity markets may enjoy. The culprit, which helped cause the euro's slide in the first place, is the robust U.S. economy.

If America's economy continues to thunder ahead as Europe ekes out another year of meager growth, the likely consequences for the euro-dollar exchange rate are clear. U.S.

Federal Reserve

Chairman

Alan Greenspan

may very well have no choice but to kick the euro down just as it is picking itself up off the floor.

This week Greenspan hinted that if the U.S. economy continues to strengthen and he begins to see inflationary pressures, he would bring the hammer down and raise interest rates. And since the

European Central Bank

isn't likely to raise rates for the rest of this century, the euro could easily test new lows against the dollar in the coming months.

On Thursday, in the ECB's first news conference since the

International Monetary Fund

lowered its growth forecast for Europe last month, ECB President

Wim Duisenberg

said after seeing a slowdown at the turn of the year, there were "preliminary indications of some improvement" for some aspects of the region's economy. The IMF expects the euro-area economy to grow by only 2% this year.

In response to a question about whether the slower growth this year could mean another cut in ECB interest rates, Duisenberg said, "last time (we cut on April 8) I said this is it for a while. Now I can say this is still it." Asked by

TheStreet.com

if that meant he now had a tightening bias, Duisenberg said, "I know my words are likely to be interpreted lots of different ways, but there is not a bias in either direction at the present moment."

Some see the euro's interest-rate woes as a long-term problem. George Magnus, chief economist for

Warburg Dillon Read

in London, points to the widening spreads between the U.S. and Europe. "We haven't seen these rate differentials for the better part of a decade. Until that changes, I think we'll see a softer euro," Magnus says.

So while it appears U.S. rates are likely to go up in the next couple of months, in the coming week, the euro will likely see some welcome relief as hope continues for a peaceful resolution to the conflict in Kosovo. Whether the euro can hold on to its peace dividend once Greenspan raises rates is another story, though.