The European Exchange Rate Mechanism, ERM, was a system introduced by the European Community in March 1979, as part of the European Monetary System (EMS), to reduce exchange rate variability and achieve monetary stability in Europe, in preparation for Economic and Monetary Union and the introduction of a single currency, the euro, which took place on 1 January 1999. After the adoption of the euro, policy changed to linking currencies of countries outside the Eurozone to the euro (having the common currency as a central point). The goal was to improve stability of those currencies, as well as to gain an evaluation mechanism for potential Eurozone members. This mechanism is known as ERM2.
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The ERM is based on the concept of fixed currency exchange rate margins, but with exchange rates variable within those margins. This is also known as a semi-pegged system. Before the introduction of the euro, exchange rates were based on the European Currency Unit (ECU), the European unit of account, whose value was determined as a weighted average of the participating currencies.
A grid (known as the Parity Grid) of bilateral rates was calculated on the basis of these central rates expressed in ECUs, and currency fluctuations had to be contained within a margin of 2.25% on either side of the bilateral rates (with the exception of the Italian lira, which was allowed a margin of 6%). Determined intervention and loan arrangements protected the participating currencies from greater exchange rates fluctuations.
Ireland's participation in ERM resulted in the Irish pound breaking parity with the pound sterling in 1979. Shortly after the launch of the ERM, the pound sterling, which was not an ERM currency, appreciated against all ERM currencies. Continued parity between the Irish pound and the pound sterling would have taken the Irish pound outside its agreed band. Therefore, the Irish government was required to break the parity of the Irish pound with the pound sterling to fulfil the ERM conditions.
The United Kingdom entered the ERM in October 1990, but was forced to exit the programme within two years after the pound sterling came under major pressure from currency speculators, including George Soros. The ensuing crash of 16 September 1992 was subsequently dubbed "Black Wednesday". There has been some revision of attitude towards this event given the UK's strong economic performance after 1992, with some commentators dubbing it "White Wednesday".[1] Some commentators, following Norman Tebbit, took to referring to ERM as an "Eternal Recession Mechanism",[2] after the UK fell into recession during the early 1990s. The UK spent over £6 billion trying to keep the currency within the narrow limits with reports at the time widely noting that Soros's individual profit of £1 billion equated to over £12 for each man, woman and child in Britain[3][4][5] and dubbing Soros as "the man who broke the Bank of England".
In 1993, the margin had to be expanded to 15% to accommodate speculation against the French franc and other currencies.
On 31 December 1998, the European Currency Unit (ECU)[6] exchange rates of the Eurozone countries were frozen and the value of the euro, which then superseded the ECU at par, was thus established.
In 1999, ERM II replaced the original ERM. The Greek and Danish currencies were part of the new mechanism, but when Greece joined the euro in 2001, the Danish krone was left at that time as the only participant member. A currency in ERM II is allowed to float within a range of ±15% with respect to a central rate against the euro. In the case of the krone, Danmarks Nationalbank keeps the exchange rate within the narrower range of ± 2.25% against the central rate of EUR 1 = DKK 7.460 38.
EU countries that have not adopted the euro are expected to participate for at least two years in the ERM II before joining the Eurozone.
On 1 May 2004, the ten National Central Banks (NCBs) of the new member countries became party to the ERM II Central Bank Agreement. The national currencies themselves were to become part of the ERM II at dates to be agreed.
The Estonian kroon, Lithuanian litas, and Slovenian tolar were included in the ERM II on 28 June 2004; the Cypriot pound, the Latvian lats and the Maltese lira on 2 May 2005; the Slovak koruna on 28 November 2005.[7] The currencies of the three largest countries which joined the European Union on 1 May 2004 (the Polish złoty, the Czech koruna, and the Hungarian forint) are expected to follow eventually.
Other countries to have since joined the eurozone, and hence left ERM II, include Slovenia (1 January 2007), Cyprus (1 January 2008), Malta (1 January 2008), Slovakia (1 January 2009) and Estonia (1 January 2011).
The Hungarian Ministry of Finance said that Hungary originally wanted to adopt the euro in 2010,[8] but this has been delayed. Experts say that the earliest date when Hungary will adopt the euro is 2015.[9] Bulgaria wanted to apply for ERM II membership as soon as possible after the EU entry. In November 2009, Bulgaria confirmed that it planned apply for joining ERM II in early 2010, but was forced to delay its application for at least one year after updated figures put the budget deficit for 2009 at 3.7% of GDP, outside the Maastricht criteria.[10] Romania plans to join ERM in 2010–2012.[11]
Sweden is expected to participate in ERM II in order to meet the convergence criteria required for switching currency, but has deliberately chosen to stay out of the mechanism so far. This choice is currently tolerated by the ECB, but it has warned that such an option will not be permitted for newer union members.[12]
The Swiss Franc had always floated independently until its currency appreciation became unsustainable during the Eurozone debt crisis, at which point it made a compromise to keep the exchange rate at a minimum of 1.20 francs to the euro, which does not constitute a peg[13]. It is important to note that Switzerland is not officially a member of ERM II as it is not an EU member and expresses no ambitions to become an EU member.
In theory, most of the currencies are allowed to fluctuate as much as 15% from their assigned value. In practice, however, the currency of Lithuania is pegged tightly to the central rate, and currencies of Denmark and Latvia deviate very little (usually less than 1%) from it.
| Date of entry | Country | Currency | €1= | Band | Notes | |
|---|---|---|---|---|---|---|
| Nominal | Actual | |||||
| 1 January 1999 | Denmark | Krone | 7.46038 | 2.25% | <1% | The Danish krone entered the ERM II in 1999, when the euro was created. See Denmark and the euro for more information. |
| 28 June 2004 | Lithuania | Litas | 3.45280 | 15% | 0% | The Lithuanian litas was pegged to the US dollar until 2 February 2002, when it switched to a euro peg. |
| 2 May 2005[14] | Latvia | Lats | 0.702804 | 15% | 1% | Latvia has a fixed exchange rate system arrangement whose anchor switched from the SDR to the euro on 1 January 2005. |
The former members of ERM II are the Greek drachma, Slovenian tolar, Cypriot pound, Estonian kroon, Maltese lira and Slovak koruna.
| Period | Country | Currency | €1= | Band | Notes | |
|---|---|---|---|---|---|---|
| Nominal | Actual | |||||
| 31 December 1998 — 16 January 2000 |
Greece | Drachma | 353.109[15] | 15% | ||
| 17 January 2000 — 31 December 2000 |
340.750[16] | |||||
| 28 June 2004 — 31 December 2006 |
Slovenia | Tolar | 239.640[17] | 15% | 0.16%[18] | |
| 2 May 2005 — 7 December 2007 |
Cyprus | Pound | 0.585274 | 15% | 2.1%[18] | |
| 7 December 2007— 31 December 2007 |
0% | The Cypriot pound has been pegged to the euro since 7 December 2007. Before then, it floated against the euro in a ±15% range. | ||||
| 28 June 2004— 31 December 2010 |
Estonia | Kroon | 15.6466 | 15% | 0% | The Estonian kroon had been pegged to the German mark since its re-introduction on 20 June 1992, and then to the euro. It was fixed in 13 July 2010. |
| 2 May 2005 — 31 December 2007 |
Malta | Lira | 0.429300 | 15% | 0% | The Maltese lira has been pegged to the euro since joining ERM II. Only two exceptions exist: 2005-05-02 (ECB rate: 1 EUR = 0.4288 MTL) and 2005-08-15 (ECB rate: 1 EUR = 0.4292 MTL).[18] |
| 28 November 2005 — 16 March 2007 |
Slovakia | Koruna | 38.4550[19][20][21] | 15% | 12%[18] | |
| 17 March 2007 — 27 May 2008 |
35.4424[22][23] | 12%[18] | ||||
| 28 May 2008 — 31 December 2008 |
30.1260[24] | 1.9%[18] | ||||
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