Talk of '2-Tier Euro Zone' Could Upset Euro: ING

Last week's rebound of Europe's single currency may be jeopardized by reports over the weekend that France and Germany are mulling a two-tier euro zone, ING Bank analysts wrote in a market note Monday.

A "super-euro" zone would initially include France, Germany, Holland, Austria, Denmark and Finland, a European official told UK newspaper the Daily Telegraph. Countries like Greece, Spain, Italy, Portugal and Ireland would be left in a second-tier group, according to the paper.

Euro bills and U.S. dollars being exchanged
Euro bills and U.S. dollars being exchanged

"The survival of the euro is again in the spotlight after weekend press reports," ING Bank analysts wrote.

The European official said the two-tier euro zone solution was analyzed as a "plan B" at cabinet level.

"The philosophy is the stronger countries might need to move away from countries they can't afford to bail out," the official said, according to the Daily Telegraph. "As a way of containing the damage, they may have to do something dramatic, though obviously in the short term implementation is difficult."

"It's an act of desperation. They are not talking about ideal solutions but the lesser of evils. Helping Greece could be done relatively cheaply but Spain they can't afford to let fail or bail out. And putting more pressure on the people of France and Germany to save other countries is politically unfeasible," the official added.

Officials from the European Central Bank stepped up pressure on governments to follow stricter rules on keeping budget deficits in check and allow external monitoring of their books.

Euro to Fall Further

ECB President Jean-Claude Trichet is due to address European parliamentarians later on Monday.

"The plain fact is that there are no easy answers to the solvency and competitiveness problems of Southern Europe," ING Bank analysts wrote.

"Whether or not the two-tier story is denied, the markets' doubts about the viability of the euro zone will continue to rumble on. This points to further downside for the euro in coming months," they wrote.

ING Bank said it maintains its forecast of an exchange rate of $1.10 for the euro by the end of the year.

The advantage of a two-tier euro zone would be that the old euro would fall sharply against the new euro, boosting weaker euro zone members' competitiveness, according to the ING Bank analysis, which reminds that academics Michael Arghyrou and John Tsoukalas argued for a version of the "two-tier euro" earlier this year.

"The essential problem with their proposal is that the 'weak euro' countries would be left with 'super euro' debts, which would initially worsen their solvency problems," ING Bank wrote.

"The markets would effectively be asked to believe that the competitiveness boost from the weak euro and 'extensive structural reforms' would give these countries a powerful enough growth stimulus to offset this initial extra debt burden."

Analysts at the bank also warned that, if such a proposal were to be seriously considered, there will be a "destabilizing" flight of capital from the prospective weak euro countries.