Weak euro a thorn in Blair's side

The continued weakness of the euro poses difficult political issues for Tony Blair. With the next British general election likely in May 2001, the question of whether the UK will join Economic Monetary Union takes on a range of considerations.

What is the betting on a scenario at election time where Mr Blair would insist it was too early to say whether Britain was ready for entry. Three weeks later, however, once safely re-elected, Gordon Brown would announce that the five economic tests he has defined for euro entry were realised, and that the referendum on entry could proceed!

It worked for Bank of England independence, so why not the euro? So let us look at Chancellor Brown's entry tests, and whether they are likely to be met.

The first test is whether there can be sustainable convergence between Britain and the economies of the single currency? This is the hardest one to forecast. The British government, assuming it genuinely wanted to join the euro, has been a victim of its own success. Had Britain suffered a recession this year while Europe was recovering, it would have been possible to talk about genuine cyclical convergence.

That is not the case. UK interest rates are double those on the continent, and with house price inflation already reaching late 1980s levels in the south-east of England, cutting rates to European levels would be disastrous.

And so to the second test. Is there sufficient flexibility to cope with economic change? Britain's labour market has been a big success story, with falling unemployment and no signs of exploding pay pressures. UK policymakers worry that because of strict employment legislation in many European countries, the euro zone won't prove flexible enough to cope with future shocks.

The third test: what is the effect on investment? Each time somebody has tried to get a scare story going on the threat of companies to withdraw investment if Britain does not join the euro, the company concerned denies it. Foreign investors appear to be taking the view that it is better to have a stable British economy outside the euro than an unstable one within it.

Would joining EMU create better conditions for firms making long-term decisions to invest in Britain? Surveys suggest the English language and the stable economic environment outweigh the disadvantages of sterling's volatility against the euro.

The fourth test: what impact would entry into EMU have on the UK's financial services industry? The suggestions that Britain would be somehow artificially disadvantaged are not proven. The City has declared it is managing perfectly well outside the euro. But how long can this go on?

The Chancellor's final test: is EMU good for jobs? Britain has had an excellent employment record and it would take a brave Chancellor to say things would clearly be better within the euro.

The real test therefore will be how the UK performs compared to the rest of Europe over the next few years. The signs are Britain's growth will outstrip Europe's this year and unemployment is already half the European level. There is a view that the longer Britain stays out, the more attractive leaving the Bank of England in charge of the UK economy will look.

But euro membership would bring some immediate payoffs. With lower interest rates, the average mortgage would be cheaper. Businesses would have lower borrowing costs and shed their exchange rate yoke. Taxes would ideally rise to offset the stimulus to the economy from lower interest rates, and the extra money could then be earmarked as a special euro boost for health, education and public transport.

There are, in fact, no economic obstacles to British membership of the single currency. The problem is a political one, with Gordon Brown said to want no distraction from his glowing record in the run-in to the next general election campaign.

But he could be wrong both tactically and strategically. The more the British government tries to down play the question of the euro during next year's election campaign, the more sensitive an issue it could turn out to be. Tony Blair is determined to prevent the Tories turning next year's election campaign into a vote on whether or not to scrap the pound.

The euro's sharp fall in value has made it more difficult for the British government to contemplate early entry. Sterling is now at its strongest for more than a decade - and the government fears that going in at too high a rate could produce a repeat of the ERM fiasco of the early 1990s.

Economist John Ryan is a euro-consultant with PA Consulting, Dublin.