The European Central Bank has deemed Britain unfit for monetary union even if it wants to join following the dramatic slide in sterling and the explosion in the UK budget deficit.
“Great Britain does not meet the entry criteria for the euro,” said Lorenzo Bini Smaghi, the ECB’s board member in charge of international affairs.
“The public deficit will rise to around 6pc (of GDP) in 2009 and even higher in 2010. Sterling’s exchange rate is not yet sufficiently stable,” he told Italy’s La Repubblica newspaper.
The entry rules impose a deficit ceiling of 3pc of GDP, two years of currency stability, and a public debt limit of 60pc of GDP. The rules were waived for political reasons to let Italy, Belgium and Greece into EMU, but terms are becoming stricter as the ECB seeks to exclude East European states before they are ready.
If anything, Mr Bini Smaghi may have been too kind to Britain. The Treasury expects the deficit to reach £118bn in the 2009 tax year – almost 8pc of GDP – but there are now fears that this will rise even higher as tax revenues collapse. Some analysts have begun to warn that Britain will soon face a deficit of 10pc, the sort of catastrophic levels seen in Latin America in the 1980s.
There is a mounting anger in EU circles over the slide in sterling, seen by some as a deliberate ‘beggar-thy-neighour’ policy evoking the Great Depression. “The 30pc fall in the pound is the biggest devaluation by any country in the single market since it was created in 1957,” said one ex-commissioner. “There is going to be a serious political reaction to this in coming weeks.”
Sterling makes up a quarter of eurozone’s export basket – equal to the dollar – and Ireland’s exposure is much higher. Irish retailers have been crippled as shoppers flood across the border into Ulster.
But there is also a misunderstanding in Brussels, Paris, and Berlin over British motives – just as there was during the ERM crisis in 1992. The Bank of England’s main concern has been to cut interest rates to head off a housing collapse and to ease credit strains. While it views the pound’s fall as an added bonus in battling slump, this is a secondary effect.
Countries such France, Germany, and Italy tend to fret more about the exchange rate, and less about the interest rates. They have higher personal savings and lower debts so rate cuts are a mixed blessing for most people.
The pound’s recovery this week from near parity to €1.09 may help blunt criticism. The euro’s Winter rally is petering out as grim data emerges from across Europe. Eurozone producer prices fell 1.9pc in November, the biggest drop since records began in 1990. Consumer inflation has fallen to 1.6pc, the lowest since the launch of the currency.
The region may be facing deflation by the middle of this year. “We believe that the ECB will eventually be cutting interest rates as low as 1pc,” said Howard Archer, Europe economist at Global Insight.
Frankfurt is loathe to follow the US, Japan, Switzerland towards zero rates, fearing that it could “run out of ammunition”. It is also wary of emergency stimulus (quantitative easing), in part because this would blur the lines between the ECB and the national treasuries. This is a political minefield. Berlin fears such a precedent could nudge the eurozone towards a debt union, enabling high-debt states to shift liabilities onto German taxpayers.
Mr Bini Smaghi noted with annoyance that Anglo-Saxon commentators now use the term “PIGS” to describe the eurozone’s Club Med bloc of Portugal, Italy, Greece, and Spain, which all have large current deficits or public debts.
“This is not a term that’s used in the euro area. They use it in other countries, perhaps to divert attention from internal problems,” he said, referring explicitly to the City. He resisted the temptation of deriding Britain as the ultimate PIG.
Mr Bini-Smaghi’s comment is a little unfair. The term `PIGS’ was first put into play by a German from a eurozone bank in a private client note. It is now widely used by currency traders and analysts from European banks, regardless of nationality. The expression has become linked to London because the City is the global centre for currency trading.
Native English speakers rarely use the term. It is the European press that has had most fun with the “PIGS” , unsually in playful pieces hinting at an Anglo-Saxon plot to do down the euro.
By Ambrose Evans-Pritchard
Last Updated: 8:47AM GMT 08 Jan 2009
Source: The Telegraph