European eyes turn to UK after fall of 'stupidity pact'

London Briefing: There has been surprisingly little gloating in Britain over the demise of the euro area's Stability and Growth Pact. I haven't heard one analyst say "I told you so", which is really astonishing since many of them did, writes Chris Johns.

The lack of a strong analytical reaction has been mirrored in the markets themselves, with the euro itself responding to Europe's total fiscal failure with nothing more than a metaphorical shrug. Indeed, it has continued to rise.

London-based analysts have often got Europe wrong in the past and the question naturally arises: are they doing so again? On the Wednesday that sterling left the Exchange Rate Mechanism (ERM, the precursor to the euro), I remember one prominent commentator telling the trading floor of a very large investment bank: "don't worry, we'll be back in by Friday".

That, of course, was over 11 years ago. I suppose he didn't specify which Friday he meant. However, the really big mistake at the time - made by almost everybody in London - was to describe the widening of the ERM bands, to accommodate France, as "the end of the ERM and the single currency project".

The British Prime Minister of the day, John Major, made precisely this claim. Are we writing off the stability pact equally prematurely? Probably not.

The lesson to be drawn from those earlier mistakes is not so much that the stability pact will be resurrected in the same way as was the ERM, but that the repercussions of its much-forecast collapse will not be that great and it will have no consequences at all for the single currency itself, at least not for a while.

Ultimately, it all depends on what replaces it. The betting is currently focused on the probability that Europe will adopt a variant of the fiscal framework used by Gordon Brown which seems to avoid all of the pitfalls experienced by the "stupidity pact".

Firstly, Brown's approach makes allowances for the cycle - borrowing has a natural tendency to rise and fall with economic ups and downs and it is perverse to try to avoid this. Indeed, the consequences can be disastrous.

Secondly, the UK approach is able to distinguish between good and bad borrowing - essentially, capital investment in sensible projects should be outside the scope of fiscal straitjackets invented for profligate Italian finance ministers. Thirdly, it recognises that heavily indebted countries should have different rules from countries that have not got a spendthrift history. Countries can get time off for good behaviour.

Critics of all this flexibility focus on its flexibility - they reckon there is far too much room for manoeuvre and that any country would be able to abuse the system at will. This strikes most sensible people as an utterly daft argument, given the obvious ability of France and Germany to flout the rules of an inflexible system.

Better to have a system that makes sense rather than one that stands no chance of success. The rules might still get broken but the transgressors will have no legs to stand on and might more easily be punished.

Things have happened that few people would have predicted. France and Germany are the bad guys, not the Italians. And now the euro zone is looking to the UK as a model of fiscal stability. Given that most people also accept that the Bank of England operates within an operationally superior framework to that of the European Central Bank it is no wonder that Blair has stopped mentioning any possibility of UK participation in the single currency. Why join something that is so obviously broken?

The amazing irony of all of this, picked up by no one, is that the UK has been able to exert such phenomenal influence over the euro area while standing outside. It was never supposed to happen this way. Many of the pro-euro arguments over the years have amounted to asserting that the only way to gain influence was to join the club. Indeed, there have been many scare campaigns about loss of British influence unless we join. Non-participation in the euro was supposed to marginalise the British way of doing things.

Well, when it comes to the big issues of fiscal and monetary management we couldn't be more influential than we are right now. And if we had joined the club we would now, thanks to the very strong euro, be coping with an implicit exchange rate of more than two dollars to the pound. I'll take our current level of influence without the exchange rate headache, thanks.