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Last Updated: Thursday, 28 April, 2005, 16:22 GMT 17:22 UK
Europe's problems make UK wary of euro
Analysis
By Ben Richardson
BBC News business reporter

Worker holding euro coins
Is a euro in the hand worth a pound in the pocket?
UK Prime Minister Tony Blair is a keen European.

He holidays in Italy, spoke French to France's Parliament and has made no secret of his desire to get Britain into the single European currency.

Mr Blair was expected to try and take the UK into the euro during the next Parliament, should he win the 5 May election.

On Wednesday, the prime minister effectively tore up the roadmap to the eurozone when he said the economic conditions were not right for membership and he could not recommend a "yes" vote in a referendum.

Convergence

Some commentators see the UK economy as being on a different track to the eurozone's, which has struggled to register strong growth.

Key to euro membership will be the dovetailing of the UK and the eurozone's economies.

So what has happened in Europe? Is there an economic meltdown going on across the Channel, or is this a short-term blip that has delayed rather than derailed the euro express?

According to Tony Dolphin, head of economy and strategy at Henderson Global Investors, interest rates are the main problem.

Mr Blair's government has set five tests that must be met before joining the euro can even be considered.

UK's five tests
Convergence with eurozone
Flexibility of European markets
Impact on jobs
Impact on financial services
Impact on foreign investment

The main one of these is convergence, or in other words, the idea that the UK and eurozone economies are sufficiently in tandem to have the same monetary policy.

Essentially - what would happen to the UK economy if interest rates were set at European Central Bank (ECB) levels?

At present, the benchmark interest rate in the UK is 4.75%. That compares with the 2% level set by the ECB.

More than halving UK borrowing costs at a time when there are fears of a house price bubble, and surging oil prices are pushing up the rate of inflation would cause significant problems, Mr Dolphin said.

While there would be an undoubted boost to demand, supply would not be able to keep up, inflation would jump and the current account deficit widen.

Heads or tails

The choice as it stands is simple - either the UK cuts interest rates to European levels or it waits for Europe to catch up.

Some euro pros
Lower costs for business
Harmonised exchange rates
Increase in cross border investment
Boost for export trade

"I can't see 2% interest rates in the UK unless there is a recession," said Mr Dolphin. "So there is a need for Europe to catch up."

That waiting game has its own set of problems.

Europe's biggest economies and the main players in the euro world are struggling to cut unemployment, reform state spending and boost economic growth.

Their labour markets tend to be inflexible and dominated by powerful unions, and red-tape is far more entangling than in the UK where difficult reforms were pushed through many years ago.

German unemployment is close to 12% and its economic growth is estimated to be 0.7% this year. For France, the picture is little better, while Italy's economic problems have just contributed to the collapse of its government.

Some euro cons
Euronotes being checked
Interest rates set by ECB not Bank of England
Interest rates not specific to UK
Most of UK trade done in US dollars
Cost of changeover to euro

The ECB has not raised interest rates for almost two years and growth has sputtered rather than sparked.

In the UK by contrast, analysts estimate that the economy will grow by about 2.5% this year, while unemployment is closer to 5%.

"European reform has been painfully, painfully slow," said Chris Hartley, director of fixed income at Insight Investment in London.

"And I don't think that it will be sufficient to convince the electorate as a whole that there is a dynamism about the European economy and we should jump abroad."

Too tight for growth

On top of that Germany, France and Italy have complained that the strict rules that euro members are required to adhere to are hampering their efforts to revitalise their economies.

Ignoring calls from the European Commission to rein in spending and complaints from smaller euro nations, the three have continued to run budget deficits in excess of 3% of gross domestic product (GDP), the EU limit.

Worker examines a euro coin
Any move by the UK to join the euro will come under close scrutiny

These spats, which threatened to destroy the Stability and Growth Pact, have damaged the credibility of Brussels and its ability to enforce fiscal discipline, analysts said.

Hardly a ringing endorsement for any would-be currency partners.

Even Mr Blair admits that at present in the UK "there is no part of business and industry clamouring to say we need (the euro) for our economy".

Analysts are expecting any European recovery to take a number of years, making euro entry an even harder proposition to sell to an often-sceptical UK public.

The Conservative Party, running against Mr Blair's Labour Party in next week's elections, has said that it would not look to join the euro.

The UK's other main political party, the Liberal Democrats, advocates joining the euro, subject to the right economic conditions and a referendum of the British people.

Judging from the state of Europe's economies, joining the eurozone is off the agenda regardless of who wins on 5 May.


SEE ALSO:
Blair signals no to joining euro
28 Apr 05 |  Election 2005
German jobless rate in shock dip
28 Apr 05 |  Business
EU rules 'won't stop UK spending'
22 Mar 05 |  UK Politics
ECB 'concerned' about euro deal
21 Mar 05 |  Business


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