When the economic conditions are right

The Liberal Democrats’ surge in the opinion polls has led to increased interest in their policies. One area of focus in this week’s leaders’ debate on international affairs is likely to be Europe, including the issue of UK membership of the euro.

The Liberal Democrats are rather more enthusiastic abut this prospect than the other two main parties. The Conservatives are opposed in principle and Labour has put forward a set of conditions that effectively allow them to shelve the issue indefinitely. But the Liberal Democrat manifesto says: ‘We believe that it is in Britain’s long-term interest to be part of the euro. But Britain should only join when the economic conditions are right, and in the present economic situation, they are not. Britain should join the euro only if that decision were supported by the people of Britain in a referendum.’

Putting aside the remote likelihood of a ‘yes’ vote in a referendum and concentrating on the economic issues, when might the conditions be right?

One argument put forward by the antis is that the depreciation of sterling since the beginning of the financial collapse has helped limit the impact on the UK economy (in contrast to, say, Greece). There is an element of truth in this argument but, although sterling fell by 24 per cent against the euro in 2008, the effect on the economy, in terms of stronger exports and weaker imports, appears to have been modest. Furthermore, although sterling is now 10 per cent higher against the euro compared to the end of 2008, it could be argued that the best time to join the euro is immediately after a sharp fall in sterling, so that any gains in competitiveness are ‘locked in’.

But joining the European Monetary Union does not just mean adopting the euro: we’d also share a common monetary policy, and in particular a common short-term interest rate, with other members. That would not be a problem at the current time. Interest rates are rock bottom in the UK and Europe. Indeed, there could be benefits from the UK joining the euro now, in the form of lower long-term interest rates.

But it might be a problem in the long term. When economic conditions return to something approaching normality, the UK authorities will be desperate to avoid, among other things, a renewed spurt in house prices and surge in mortgage lending. Setting interest rates at an appropriate level will be one means of achieving this aim. But that option would not be available if interest rates in the UK were being set by the European Central Bank based on economic conditions across the whole of the euro-area.

Ironically, joining the euro in the present economic situation would probably have little effect on the UK economy; the risk of such a move would only become apparent in the long term.

Tony Dolphin

UK exports collapse in January

The latest UK trade figures were awaited more eagerly than usual. Exports are seen as crucial to the UK’s economic recovery and the main political parties are all eager to present themselves as having the best policies for the sector.

Figures released on 9 March show the UK’s trade deficit in goods widened to £8.0 billion in January from £7.0 billion in December. This was mainly the result of a 6.0 per cent fall in export volumes (excluding oil and erratic items).

This will come as a blow to those looking to the export sector to strengthen the UK economy’s recovery from recession. Sterling’s effective exchange rate fell by 25 per cent in 2008; this was supposed to make UK industry more competitive and boost overseas sales of British goods. So far, there is little evidence that this is happening.

The January data are probably a blip – trade data are among the most erratic of all data releases. More worrying is the underlying trend, which shows only modest growth in export volumes over the last year. Of course, this is due in no small part to the weakness of demand in the UK’s main export markets, particularly in the rest of Europe, and it should be that export growth will improve once Europe’s economic recovery picks up speed.

There are also some grounds for optimism in the latest business surveys. The Bank of England’s agents’ report and the CBI’s survey of manufacturing both show a steady improvement in optimism about the outlook for exports in recent months. However, the Bank of England does note that some companies are taking advantage of sterling’s weakness to push up profit margins, rather than allowing it to feed through into enhanced competitiveness. Depending what happens to these higher profits, this probably means some of the potential benefits of sterling’s fall - in terms of more exports, more output and more jobs - are being lost.

Tony Dolphin, senior economist, ippr