Rather than putting the euro debate to one side to make way for more pressing concerns, Blair is more focused than ever
It was starting to look like UK Prime Minister Tony Blair's ambition to take Britain into the euro would be derailed by his new duties as person in charge of keeping everyone on board in the global war against terrorism. Instead, he seems more determined than ever to force the issue.
'We should only be part of the single currency if the economic conditions are met,' Blair told the Labour Party's annual conference. 'If met in this parliament, we should have the courage of our argument to ask the British people for their consent' in a referendum.
The economic conditions are perceived as the Government's get-out-of-jail card on the euro. If the Government judges that the project doesn't meet its five tests”the euro must be good for UK jobs, investment and financial services and able to withstand 'economic shocks,' and Britain's economic cycle must be sufficiently aligned with existing euro members”the promised referendum can be avoided.
Blair's comments this week suggest the Government is willing to take its chance, even though polls consistently show about two-thirds of Britons are opposed to scrapping the pound and becoming the euro's 13th member.
'While Blair arguably said nothing new, the comments are important in that the government is pushing the debate firmly back on the agenda,' said Ciaran Barr, chief UK economist at Deutsche Bank AG, in a research note. 'After all, the Prime Minister was under no obligation to comment at all.' The reaction in the currency market to this renewed commitment has been oddly muted. Typically, the closer the UK looks to joining the common currency, the lower sterling falls on expectations the Government would want to preserve exports to the European Union by driving down the pound's entry level.
At about 62p per euro, however, sterling hasn't budged this week. That leaves the pound worth about DM3.15, in line with its average value in the past six months and well above the DM2.95 which proved unsustainable in 1992, when the UK currency's peg to its European peers snapped.
Which suggests either that people in the currency market don't believe Blair will succeed in selling the euro to a reluctant electorate, or the perceived 'comfort level' for sterling has been ratcheted higher as the economy proves good at coping with the pound's current value. If the currency market isn't giving much of a steer on whether investors and traders believe the UK is likely to become a common currency member in coming years, maybe the bond market can be mined for clues.
Forward-curve analysis uses current market rates to reveal the assumptions investors and traders are making about future yields. For example, the money-market gives you a yield on a six-month investment. By calculating the returns needed to match that yield by making two separate three-month investments, one today and one at year-end, you can work out what assumptions are embedded in money market rates about where three-month rates will be in December.
Since joining the euro would drive UK yields near those of Germany, Europe's benchmark market, forward-curve analysis can help indicate whether membership is being anticipated.
Five-year UK Government swap yields are currently about 5.22%, some 84 basis points higher than their German counterparts. That reflects the different monetary policies governing UK and German securities, as well as the different currencies they're denominated in.
Forward-curve analysis shows those rates converging in coming years to a gap of just 16 basis points, with five-year UK swaps at the end of September 2004 of 5.62% and German swaps of 5.46%. That may indicate investors are anticipating the UK will adopt the euro.
This kind of analysis is deductive, rather than predictive. It tells you the current state of play in the bond market; I'd be sunning myself on my yacht rather than bashing at this keyboard if charting the matrix of current yields was an infallible guide to where bonds are headed.
Nevertheless, similar analysis in the years prior to the January 1999 start of economic and monetary union proved useful in sorting through the static to determine whether investors expected countries such as Italy and Spain to make the grade. So the bond market seems to be suggesting Blair will be rewarded for having the courage of his convictions on the euro issue. It'll be interesting to see if that's reflected in opinion polls in the coming months.
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