Will the U.K. Enter the Eurozone?

Though this questions may seem prima facie absurd, there has been some whispers in the air since the onset of the financial crisis. Strong public opposition and the Brits' reluctance to fork over control of monetary policy remain significant hurdles, but several other barriers have been eroded. At some point in the future, it will be too advantageous for Britain not to switch and national pride will most likely be overcome. The two key issues are valuation and autonomy of monetary policy. Even EU Chief José Manuel Barroso acknowledged last year that the whispers might be credible when he told a French radio station:

"We are now closer than ever before. I'm not going to break the confidentiality of certain conversations, but some British politicians have already told me: 'If we had the euro, we would have been better off'."

One problem is the overreliance of British GDP on the financial sector. Britain probably suffered more than any other developed economy (minus Iceland) in the world because of the City's importance. The complete overhaul of the British banking system and the remaining poor loan quality will have lasting effects similar to, if not worse than, those in the United States. Because the Labor government ramped up extensive monetary and fiscal stimulus, Britain may now be forced to watch the steady erosion of the pound. The fall of the pound is significantly underreported when compared with the myriad stories of the dollar's demise, though both currencies face similar supply situations. 2009 has seen some gains, but the pound has suffered deep declines against both the Swiss franc and the yen, in addition to worse declines against the commodity dollars of Canada, New Zealand, and Australia.

GBP/JPY

click to enlarge

GBP/CHF

The most important chart to observe is the EUR/GBP which provides us with significant technical reasons to believe that the euro and pound will move towards parity over the next year or so. Observe the three bounces off of the long-term trend line:
EUR/GBP

If the euro and pound do go to parity and beyond, it will only increase pressure on the Britain to make the switch. Potential deal-maker: a compromise allowing less regulation of the City, but bringing Britain into the eurozone and giving it some significant influence at the ECB. Its certain that any deal would have to include a significant British role at the ECB. Additionally, it might come down to an act of necessity for the UK if further financial or economic turmoil is to come. The pound was under significant pressure in the fall of 2008 and was pushed to the breaking point (thus the spike on the EUR/GBP chart to .98). Although a recovery seems to be underway, the Brits should be wary of any potential complications.
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Comments

[chap08:]

No the UK will not enter the Eurozone. The Conservative party will win the next election and will move away from, rather than closer to, Europe. That means that it is a non starter for, I think, 5 years.

When that 5 years is up, it is possible that the Euro will no longer exist. On balance I think that the Euro will survive, but failure is a serious possibility. It is hard to see how the conflicting requirements of say Ireland, Spain, Italy and Germany can be resolved without major problems. The strength of the Euro is temporary, not permanent.

Oct 23 09:39 AM

[Dave Wrixon:]

Well the concept that Euro will no longer exist is nonsense. It has been tested during the most severe of financial crisis and has come out the clear winner.

The idea that the UK's structural debt problems are as severe as those of the US is a complete fallacy. The UK simply took a huge one off hit on it banks, as it was the most proactive government in terms of taking an equity holding. The value of those equity holdings is primarily dependent on the Real Estate Market. The UK Real Estate market is remarkable firm and not comparable to that of the US. When market conditions are right the UK will privatize its banks, almost certainly at a healthy profit. The UK simply does not have the levels of multi-decade structural deficits that the US does.

The biggest problem with the UK joining the Euro as I see it is that that it would give the Euro the critical mass required to become the dominant currency. But the Europeans may not see that as a good thing, because a strong currency would weaken the Eurozone economy at a critical time, and it would be even worse in the UK to have a strong currency at this time.

Oct 23 12:44 PM

[Vaun:]

So you're saying that it's harder to meet the conflicting needs of 16 countries than of the 50 states in the US? The Euro will survive.

Oct 24 12:25 AM

[Student of ...:]

chap08:

I'd have to say that history is probably on your side... Monetary unions never survive (such as the Latin Monetary Union and Scandinavian Monetary Union). I don't think it is possible to coordinate the fiscal policies and monetary policies of all the EU members in the long term. Also, the growth and stability pact has been a source of contention among EU members since the inception of the Euro.

en.wikipedia.org/wiki/...

I would bet that Ireland is kicking itself for joining the EU. England is currently eating their luch in terms of exports due to a week pound...


On Oct 23 09:39 AM chap08 wrote:

> No the UK will not enter the Eurozone. The Conservative party will
> win the next election and will move away from, rather than closer
> to, Europe. That means that it is a non starter for, I think, 5 years.
>
>
> When that 5 years is up, it is possible that the Euro will no longer
> exist. On balance I think that the Euro will survive, but failure
> is a serious possibility. It is hard to see how the conflicting requirements
> of say Ireland, Spain, Italy and Germany can be resolved without
> major problems. The strength of the Euro is temporary, not permanent.

Oct 24 04:06 PM