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Thursday, 24 May, 2001, 10:10 GMT 11:10 UK
Is the UK ready for the euro?

by BBC News Online's Steve Schifferes

Despite Labour's attempt to downplay it, Britain's membership of the euro, the single currency shared by 12 EU countries, is already a key election issue.

Euro timetable
Jan 1999: Euro introduced in 11 countries
June 2000: Greek membership approved
Jan 2002: Euro banknotes circulated
February 28 2002: National currencies withdrawn
2003: Labour decision on euro referendum if elected

The Tories are likely to increase the pressure on the euro as the campaign enters its final weeks, calling on voters to save the pound, and stressing the sovereignty issue.

Labour wants to keep the argument on economic grounds. It says it has no objection in principle to euro membership, but will put the issue to Parliament and a referendum if it is in Britain's national economic interest.

The Liberal Democrats strongly back UK membership of the euro, but only at a reasonable exchange rate which protects manufacturing industry.

So how should we evaluate the economic debate on the euro?

"One size fits all" monetary policy

Under euro membership, UK interest rates would be set by the European Central Bank in Frankfurt, while the value of the pound would be fixed against other European currencies.

Labour's euro tests
Better for jobs
Better for investment
Better for the City
Flexible labour markets
Economic cycles compatible
Critics like Shadow Chancellor Michael Portillo argue that it would be bad for Britain - because the interest rate appropriate for the German economy may not be right for the UK.

But many large companies would argue that fixed, stable exchange rates would help UK exports and make price comparisons easier across Europe.

The problems that the UK would have in adjusting to EU interest rates, however, depends on whether the UK economy is now performing in cycle with the rest of Europe. This is known as convergence and is the key economic test set by Labour before recommending membership.

And perhaps surprisingly, many economists, both eurosceptic and europhile, now believe that Britain's economy - and its interest rates - are moving closer to those in Europe.

Professor Tim Congdon, of Lombard Street Economics, a firm eurosceptic, says that long-term interest rates in the UK are now broadly in line with those in Europe.

And he believes that difference between the Bank of England's base rate (now 5.25%) and the ECB rate (4.50%) will diminish over time.

Martin Weale, head of the respected economic forecaster the National Institute for Social and Economic Research says that the differences between countries within the eurozone are now greater than the difference between the UK and the rest of the eurozone.

And Richard Portes, Professor of Economics at the London Business School (and president of the pan-European think tank CEPR) believes that the UK already suffers from the problem of "one size fits all" interest rates, with Northern manufacturing suffering from the higher rates needed to slow down growth in the South.

Exchange rate issue

More problematic for Britain - although not included as one of Labour's economic tests for membership - is the question of what rate sterling would join the euro.

Most economists believe that the pound is over-valued compared to the euro, making British goods more expensive and making if more difficult for UK manufacturers to compete with their Continental rivals.

The Liberal Democrat's Malcolm Bruce has suggested that the pound would need to fall by at least 5% to 10% against the euro, to help British industry.

He suggested that the next government could negotiate an entry rate with other EU governments.

Some economists, like Richard Portes, believe that the euro will eventually rise in value, weakening the pound and making UK entry easier - and that the ECB would be happy to negotiate a lower rate for Britain.

However, others say that the EU will only allow Britain to join at the market rate of exchange, which the UK might find difficult to influence on foreign currency markets.

Economic or political decision?

Most economists admit that the economic arguments for euro membership are finely balanced - with some stressing drawbacks like the one-off costs of transition to euro notes and coins, while others the benefits from increased price competition and Europe-wide capital markets.

Most also believe that in the next few years the economic arguments could become more favourable for membership - if Britain's economy and interest rates move even closer to those in the eurozone, and the pound falls in value.

Pro-European economists, however, say that the Chancellor could do more to help the process - and suspect he is unenthusiastic about the process.

Mr Brown has also expressed doubts about the way the ECB is run, compared to the Bank of England.

The tensions within as well as between the parties over the euro may well increase over the next few weeks.

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