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.

Labels: Euro, UK economy