How the euro could harm Britain

ADOPTION of the euro would expose the British economy to 'considerable risks' and could threaten the City's position as the financial centre of Europe, the Bank of England warns today.

John Townend, the Bank's director for Europe and an expert on euroland finances, expresses strong doubts as to whether the UK could live with the 'one-size-fits-all' interest rate and fiscal policies in the single currency area.

He argues that there would have to be a substantial devaluation of the pound against the euro if we were to join the currency. 'The sterling exchange rate is clearly overvalued, at least against the euro,' says the Bank of England insider.

If there were to be a devaluation 'this would be bound to put strong upward pressure on UK inflation' which could in turn lead to higher interest rates.

Townend's forthright views concur with those of his boss, Governor Sir Edward George, who has highlighted the severe problems that would be created by imposing a single interest rate across 12 very different nations.

As the leading Bank of England authority on the euro, Townend praises Brussels and the European Central Bank for their logistical success in launching the euro notes and coins. But despite Labour's efforts to use the launch to whip up enthusiasm for the single currency, he says it is far too early to tell if the arrival of the physical currency will change public opinion. That, he says, will become evident as Britons make their annual 400m journeys to Europe each year.

Foreign Office Minister Peter Hain and euro-enthusiast Peter Mandelson have been among those urging the Government to speed progress towards a referendum and British entry into the single currency zone.

Like the Paris-based Organisation for Economic Co-operation and Development last week, Townend appears uncertain that Europe is economically equipped for the single currency and is critical of the European Central Bank over its inability to explain the interest rate decisions it has made over the last three years. 'The risk is that the single interest rate may not, in practice, suit all the participants in European Monetary Union all the time,' he says. 'At any particular moment it may not precisely suit any of the participants.'

The 12 euroland countries may, as at present, face different budgetary conditions and be affected in a variety of ways by external shocks, such as a change in the oil price or the burst of the technology bubble.

Townend adds that one way to address differences between countries and regions is through financial transfers but 'no one is arguing to raise the European budget to allow significant transfers'.

One way of bringing about more convergence between the euroland nations is by improving the functioning of markets through Thatcher-style supply side reforms. These will be discussed at the Barcelona summit in March.

Townend outlines how Britain and the City have benefited as a financial centre by being outside euroland rather than within. 'London has continued to thrive as an international financial centre because of its openness and balanced regulation,' he explains. If the City were not to lose advantage by joining euroland 'a number of barriers in securities markets still need to be removed'.

He urged the 'wise men' appointed by the European Commission to make the changes to get on with what was a complex task and potentially could take years to complete.

The future of the City has been identified by Chancellor Gordon Brown as one of the five tests currently being assessed for euro entry. The Bank makes clear that 'the most positive and constructive contribution that the UK can make at present is on the outside'.