Thursday, March 1, 2007

Why the UK will never join the EURO.

From a political perspective the UK has always been reluctant to submerge itself in a European identity. The EU, with its prescriptions on the shape and size of bananas,(1) remains an easy target for UK tabloids and satirists. The idea of giving up the £ for a nondescript EURO would hardly make for a populist political agenda. However, political arguments aside, there is increasingly little if any support for the EURO, even from a purely economic point of view.

Firstly the supposed benefits of joining the EURO are becoming increasingly marginal.

1. Exchange Rate Stability. A main advantage of joining the Euro is that it reduces exchange rate volatility with our main EU trading partners. However since 2003 the £ has displayed very little exchange rate volatility. In this article. Stephen King, Chief Economist at HSBC claims that in effect the UK has already in effect joined the Euro. Anyway it is also relatively easy to insure against exchange rate movements through the purchase of currency on the open markets. Therefore at the moment there is little risk associated with exchange rate fluctuations.

2. Inward Investment.
Inward Investment has continued to soar even outside the EURO. It was thought joining the EURO was necessary to attract sufficient inward investment. However it appears that a separate currency has not been a deterrent to further inward investment. See: Inward investment in UK

3. Low inflation. There was a time when the UK was known as the “sick man of Europe” its economy characterised by, boom and bust cycles and high inflation. It was thought that joining the EURO would give the UK a strong anti inflation framework. However since the MPC was given independence in 1997 inflation has remained close to the government’s target of 2%. Furthermore this low inflation has been consistent with an enviably high growth rate. When your economy is outperforming the Euro Zone there seems little reason to join.

Joining the Euro would give the UK a small gain in terms of lower transaction costs and greater exchange rate stability. However it must be emphasised for many businesses, both domestic and foreign, these costs are a small % of total costs. However many economists fear that joining the Euro could lead to some significant economic problems.

Disadvantages of Joining Euro

1. Loss of Independent Monetary Policy. On joining the EURO interest rates would no longer be set by the MPC. They would be set by the European Central Bank. The ECB look at the whole EURO economy and not what is best for the UK. Thus if the UK joined now interest rates would fall from 5.25% to the ECB rate of 2.25%. This fall in interest rates could cause and further boost the buoyant Housing Market and cause future inflationary pressures.

2. Difficulty in getting out of a recession.
On the other hand if the UK suffered a recession they would be unable to cut interest rates. It would be difficult to boost demand and get out of the recession. To an extent this occurred in 1992; the UK was in a recession but because they were in the ERM (2) they were trying to maintain a high value of the £. Thus interest rates were far too high (15%) these high interest rates exacerbated the UK’s recession.

3. Sensitivity to interest Rates. The nature of the UK housing market means the UK economy is sensitive to changes in interest rates. Unlike European countries most UK householders own their own house, their variable mortgage is a high % of their income. Thus even a 0.25% change in interest rate can significantly affect disposable income. If the UK were to join now and interest rates were to fall by 2% it would very likely cause a further boom in the housing market which would feed through into higher inflation.

4. Loss of independence of Fiscal Policy. The growth and stability pact limits the levels of government borrowing to 3% of GDP. This is another difficulty in getting the economy out of a recession. However it would not affect the UK at the moment. Also France and Germany have conveniently been able to sidestep this rule when necessity demanded.

The UK economy is doing relatively well, by historical standards the UK economic performance is quite remarkable. Thus there seems little incentive for a British politician to take on the entrenched Euro scepticism prevalent in British media and society. There is little to be gained by joining and there are many potential problems, the Queen’s head is safe for the foreseeable future.

By: R.Pettinger

See also:

Benefits of Joining EURO

Costs of Joining Euro

(1) This is actually a myth. The EU never had a regulation about the shape of bananas, but the point is it has entered British folklore.


Bill Jencks said...

These are old arguments against joining the Euro which don't really apply now - in this economic crisis.

I've just read some news from Reuters here:

..which is headed "UN Panel says World Should Ditch the Dollar". This is a recommendation buy a UN panel of economic experts.

So how will the pound fare if the dollar suddenly loses its world reserve status?

I'm thinking we would be far and away better off NOW if we had joined the Euro - simply because it will soon become a matter of currency as well as economic survival for UK.

Anonymous said...

Britain is set to be the first to come out of recession, way before those using the euro.

Mainly due to us having our own currency!

Oskar said...

Britain is, or rather was, set to do many things before the EU... Pity that's not happening, ever. Meanwhile the German productivity is picking up, while the UK stagnates at best, banks keep on crashing and Brown orders a new injection of cash.

Oskar said...

Britain is, or rather was, set to do many things before the EU... Pity that's not happening, ever. Meanwhile the German productivity is picking up, while the UK stagnates at best, banks keep on crashing and Brown orders a new injection of cash.

Anonymous said...

I agree that the the UK's unique economical disposition requires it to have an individual currency to control its inflation and employment rates

@oskar germany is really a misleading example of countries in the eurozone since they effectively control its inflation rates ofcourse they'd do fine but if the uk had to abide by the same riles they would be much worse off than they are now

Anonymous said...

I live ouside the EU and the perception of the pound compared to the Euro by institutions and people here in SE Asia demonstrates the pounds' total irrelavance compared to the Euro. My pension is paid in pounds and I and thousands are losing out. I will consider opening a Euro account for my pension payments. Ditch the pound now. Its usefullness is only propagated by corny little englanders dressed and wrapped in corny union jacks. There's little else going for it.

Anonymous said...

The Euro has now become the safe haven for investors. The dollar and the pound have been trashed by the stigma of the mortgage and banking crisis and the subsequent "quantitive easing" (printing money), the culture of high personal debt in the USA and UK, the haemorrage of dollars and pounds on deficit spending by goverments on war and the sesimic shift of both economies to the service industries which dot not create wealth, except for the very few. Germany is actually a model of a Western economy that has managed to maintain its industrial base and its inherent wealth by long term, continuous investment in its infrastructure, the sound vocational education of it's people and a ruthless focus on Quality. Britain and the US are now decades behind.

We (the UK) should join the Euro now before it is too late. The current exchange rate is about right to make the transition.

Anonymous said...

This article isn't credible . The first argument in favour of the Euro is that it Eliminates rather than "reduce" exchange rate volatility within the Euro zone. The article then says there has been very little volatility ??!!! What planet is the writer from? The Queens head is safe also as UK euro coins would likely carry the Sovereign's head and as for banknotes the tradition is relatively recent in UK history anyway.

Gerry, London said...

Yes, Britain should join the euro. The irrational fears that we will loose our 'identity' are totally unfounded and misleading. The Eurozone has weathered the recession much better than the UK. Also, it would be much better to join the euro tradewise. Imports and exports would be the same and Britons wouldn't feel squeezed by the exchange rates (as they do now)

fusilier said...

One of the reasons for the formation of the EU was to prevent future European wars. I take students to Brussels to visit the EU institutions. Later I take them to a war cemetery. I then present them with a choice. They are sensible and see the reason for the EU.

Tejvan Pettinger said...

fusilier said...

One of the reasons for the formation of the EU was to prevent future European wars. I take students to Brussels to visit the EU institutions. Later I take them to a war cemetery. I then present them with a choice. They are sensible and see the reason for the EU.

Very Good. But, what does that have to do with the Euro?

The EU and the Euro are different things.

It is quite possible to have international friendship and harmony without sharing the same currency and same monetary policy.

Anonymous said...

Just look at Greece as an example of being screwed and inside the euro. We're not going to die being outside it, and as there are no formal mechanisms for leaving we'd be stuck inside it, being told what to do by an institution that didn't give a toss about our economy, just the political bonus of having another country to dictate to.

Anonymous said...

Bill Jencks

Old arguments have a way of biting you in the future. There really isn't any inherant difference in the Euro compared to other fiat currency except its value in relation to other currencies (economies). All fiat currencies value, including the Euro, will change if there is a flee from the US dollar. This is what you call fundamentals of economics. Currencies come and go. Ever here talk about the Amero?

Anonymous said...

The Euro presents a conundrum for the UK the powerful in politics cling to the power independence gives them.
Meanwhile farmers choose to be paid in Euro. The millionS of UK citizens who will soon return to Greece and Spain to spend Euro would rather just join now.
Germany was quite happy to see the run on the Euro versus the Dollar last year. The currency wars are fought in different way by each country.
What has become obvious is that they will all stick it out, the Euro is going to win.
George Soros says so.

Anonymous said...

It is true - as someone said it already - Europe was born to avoid future wars and the Euro came with it. Our fear here in Britain is that we will be 'one of many'and not the 'Empire' any more.The relative strenght of our pound relies on the 'Taxhaven Status' of London where it earns us about 25 % of the GDP. Can imagine that the world around us will press for a change in the future . This is the real reason for not joining "fiscal independency". Dont forget most of the trillions in british created tax-enclaves are mostly from members of the 'house of lords' so it is guessed.