City viewProblems!

Proponents of the euro claim this will bring lower interest rates to the UK. But would this be of benefit to the economy or might it create more problems than it solves?

We are pleased to feature a personal view from: Dr John Whittaker, Economics Department, Lancaster University, Lancaster LA1 4YX, UK.

(Note that these comments were made in the May 1998 context

1. We don't want lower short term interest rates in the UK at present - the Bank of England argues plausibly that 7.25% is necessary to keep the lid on UK inflation. Long term rates are market driven, largely by expectations of future inflation and short term rates. So the best way to hold long rates down is to have a Bank of England which people believe will be tough on inflation. And the Bank is doing well in this pursuit at the moment.

2. If we joined the Euro now, our short rates would fall towards core EU rates of 3.5%. This would be disastrous for us (as it will be for the Republic of Ireland). It would cause a boom like the late 1980s had, followed by the inevitable bust.

3. In summary, the only way to have permanently low (short and long) interest rates is to have low inflation, and low expectations of future inflation.

4. There is plenty of disgreement on the prospects for euro interest rates. My view is that short rates for the euro will rise a lot higher than 3.5% as the new European Central Bank (ECB) wants to establish its anti-inflation crediblility in the face of almost inevitable increases in 'EMU-11' government spending despite the stability pact.

Will euro long-term rates be low? I don't know. It depends on whether the ECB sticks to its inflation objective or is persuaded by severe national pressures to be a bit laxer on inflation.

A former Referendum Party candidate who works in the City added:

However, because of the Maastricht Convergence-induced lower interest rates across the EMU block, their economies are staging a partial comeback and so there could be an argument that the EMU interest rate will actually be higher than the 3% - 4% rate much touted around.

So while Britain's rates should start to converge with that of the Euro (under Phases 1 and 2 of EMU to which we are a signatory) there might not be much between the two over time, with one slowing economy to one starting to gear up.

Additionally, any interest rate differential between LIBOR and the Euro rate arguably could be eroded over time due to arbitragers borrowing in Euros and investing in Pounds, punting on a weakening Euro.

But let's not forget what is always craftily omitted from pro EMU talk - they've got far higher income taxes in the EMU block than we have here. Top level tax in Germany and France is not far off 60%.

So yes 'Yippee - lower Euro mortgage rates', but 'Sorry, you can have back this Euro income tax bill' !
Can't have one without the other....

[slightly abridged]

Editor's footnote: In November 1998, a Bank of England Press Office spokesman confirmed that there was theoretically no reason why the Bank's Monetary Policy Committee cannot theoretically move Sterling interest rates to the Euro level, but there will only be few times in the economic cycle when needs coincide. Warrington MP Helen Jones pointed in the House of Commons, 26 October 1998, that adopting the Euro rate would require an extra 30 Bn in taxation to rebalance the economy.

This page updated: 2 January 1999

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