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Doubts resurface about Slovakia's euro entry – analysis

EU

The Slovakian central bank left its key interest rates on hold Tuesday as the new European Union member state gears up for its final push to join the euro amid fresh warnings about the nation's inflation outlook and need to cut public spending.

The Bratislava-based national bank's move to leave its repurchase rate at 4.25% for the second month in a row coincided with media reports that the European Central Bank had cast doubts on Slovakia's chances of keeping the lid on inflationary pressures. It called for more action from Bratislava to trim government expenditure. This has helped reopen debate on Bratislava's prospects of meeting its deadline for joining the euro in January 2009. The ECB “wanted to warn Slovakia against excessive optimism and confidence over the euro entry and suggested to the government that it should keep a tight fiscal stance,” said Stanislava Pravdova, analyst with Danske Bank. “In our view, there is still a chance that Slovakia, despite fulfilling the inflation criteria, will be blocked from joining the eurozone partly due to the reluctance of the Slovak government to keep spending under control,” said Pravdova.

ECB chief Jean-Claude Trichet has repeatedly taken a hard-line stance on new EU states wanting to join the euro insisting that they had to strictly adhere to the tough fiscal targets for signing up to the common currency. May annual inflation in Slovakia edged down to an eight-month low of 2.3% (from 2.7% in April) raising confidence in Bratislava that the nation will be able to meet the strict inflation reference rate of below 3.0% for euro membership. In a report released last week, the IMF said Slovakia was “well poised to adopt the euro,” in January 2009 with the nation's plans underpinned by prudent macroeconomic management. But the IMF also warned Slovakia that it needed to address fiscal spending.

The Slovakian national bank's decision to leave rates unchanged at 4.25% also came as analysts speculated whether the ECB will deliver another 25-basis-points increase in the cost of money possibly in September. This follows the Frankfurt-based ECB's decision earlier this month to raise borrowing costs in the 13-member eurozone to 4.0% as a result helping to pave the way for Slovakia's monetary convergence with the currency bloc. Next year will be a critical for Slovakia with European officials set to decide whether Bratislava has met the tough fiscal conditions enabling it to fulfill its ambitions of joining the euro in January 2009.

Last week, EU leaders gave the go-ahead to Cyprus and Malta joining Europe's common currency zone in January. EU finance ministers are expected to give final approval next month to Cyprus and Malta adopting the euro, as a consequence expanding the currency bloc to 15. However, Slovakia would represent the first of the leading new EU states to join the euro with Poland, Hungary, the Czech Republic still to formally set out dates when they plan to join Europe's common currency.

In the meantime, a recent strong performance by key Central European currencies and growing faith among the region's central bankers that inflation is ebbing have helped to eased pressure for tighter monetary regimes. Indeed, Tuesday's decision by the Slovakia monetary authorities to keep rate unchanged also came in the wake of the decisions by both the Hungarian and Romanian national banks to trim borrowing costs this week. The series of rate announcements form part of the current monthly round of meetings by central banks in the new EU member states.

Both the Polish national bank and the Czech central bank are widely expected to keep rates on hold at their meetings set down for later this week. Although analysts believe that strong growth in both nations risks helping to fuel inflation, which in turn could force the countries' central banks to tighten in the coming months. With official rates in the Czech Republic expected to remain on hold at 2.75% (4.25% in Poland,) moves by the world's leading central banks to lift borrowing costs could also add to the pressure on the monetary authorities to increase the cost of money. While Slovakia, Cyprus, Poland, Hungary and Malta were among the 10 largely Central European states that joined the EU in May 2004, Romania only joined the Brussels-based bloc in January this year. (monstersandcritics.com)

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