If EMU starts on 1 January 1999, at least two things will happen: exchange rates will be irrevocably fixed and their fluctuation margins will be eliminated. This implies that exchange risks between participating currencies will vanish and forward interest rates, with a settlement time after the EMU starting date, should be equal. In Discussion Paper No. 1395, Research Fellow Paul De Grauwe derives the probabilities that markets attach to the occurrence of EMU by assessing deviations between these forward interest rates.

De Grauwe’s calculations suggest first that markets expect EMU to happen between the DM, the French franc (FF) and the guilder, but there is doubt over the entry of the Belgian franc and sterling. All other entry probabilities are considered low. Second, markets attach a very low probability to the ECU being transformed into the Euro, with irrevocably fixed exchange rates. De Grauwe interprets this evidence as a disbelief that EMU will start in 1999. To resolve this inconsistency, he suggests that markets seem to be confident that some kind of monetary union or fixed exchange rate regime will exist between the DM, FF and guilder but that it may not take the precise form prescribed in the Maastricht Treaty.

Forward Interest Rates as Predictors of EMU
Paul De Grauwe