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Friday, 8 June, 2001, 12:59 GMT 13:59 UK
Labour faces euro decision

by BBC economics reporter Jenny Scott

Love it or loathe it, the euro is set to dominate Labour's second term of office.

Having safely secured a massive majority, the government has relatively little time to say whether it is converting "wait and see" stance on the single currency, to one of "campaign and convince".

The government may feel the need to talk down the pound to turn public opinion around, so it can launch the campaign in earnest

Jonathan Loynes, chief UK economist, Capital Economics

Already, businessmen and activists on both sides of the euro divide have begun to mobilise for the expected debate ahead of any referendum.

Labour has said it will decide within two years whether the UK economy meets its five economic tests for euro membership, which would trigger a recommendation from the government to join the single currency.

But Labour's exact game-plan - and the final outcome - is far from certain.

On your marks

The one thing campaigners from both sides of the euro divide do agree on is that Tony Blair and his cabinet colleagues are likely to push the national debate on the single currency to the fore as soon as possible.

The majority of Britons are opposed to euro entry. Up against those odds, there's likely to be an early, but subtle attempt to soften public opinion.

With that in mind, chief UK economist at Deutsche Bank, Ciaran Barr, expects the government to wage a "shadow" campaign, after a respectable post election pause.

"They'll see how the ground lies, see if people can be persuaded, make pro EMU comments and see how they are received," he says. "If they make inroads, they can then campaign properly."

Some economists say that if all goes according to plan, the Chancellor Gordon Brown will then announce that the UK meets the five economic tests, ending in a referendum on the issue in around two and a half years' time.

That would allow a decision to sneak in ahead of any mid-term blues, and would also prevent the issue from taking centre stage in a subsequent election.

Five tests

However, there are some formidable difficulties with that scenario. For one thing, opinion is divided as to whether the five economic tests will be met within the next two years.

Labour's euro tests
Better for jobs
Better for investment
Better for the City
Flexible labour markets
Economic cycles compatible
Economists at the independent think tank, the National Institute for Economic and Social Research, believe the British and European economies have already converged to the point where the government could prepare for euro entry.

However, it also argues that this comes at a price. It says income tax would have to rise by 2p, or public spending cut by 12 billion in order to meet Europe's strict fiscal rules.

Ciaran Barr agrees that meeting the tests is unlikely to be a problem. They are broad enough to allow the government to present an economic case either for or against entry, depending on the political will of the day.

However, others are less sanguine.

"There'll certainly be legitimate grounds for saying that the tests are not fulfilled," said Investec's Philip Shaw. "There has undoubtedly been some convergence of economic cycles, but there's still a gap between short term interest rates."

The cost of borrowing in the 12 eurozone countries is currently 4.5%, lower than the 5.25% in Britain.

It may not seem like a particularly large gap, but given that the difference between the peak and trough in the whole of the last UK rate cycle was just one percentage point, it could cause a problem.

Level of the pound

The level of the pound against the euro is also a potential stumbling block.

The single currency has had a rough ride since its launch two and a half years ago, losing more than 15% of its value against the pound.

That has made British exports to Europe, one of the UK's main markets, more expensive. Manufacturers will be keen not to lock the pound into the euro at such an inflated rate for fear of losing even more market share and profits.

It could therefore be an uphill struggle to convince UK Plc of the merits of joining the euro without knowing sterling's entry rate into the system.

"There's a bit of a chicken and egg situation with the pound," says Jonathan Loynes, chief UK economist at Capital Economics. "The government may feel the need to talk down the pound to turn public opinion around, so it can launch the campaign in earnest."

The question of British entry to the single currency is arguably the most important economic and political decision for a generation.

However, despite the new Labour majority, it's still not clear it's one that will be taken during the lifetime of this parliament.


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