Will the U.K. Enter the Eurozone?

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Includes: FXB, FXE, FXF, FXY
by: Kevin Mulhern

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


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.
Disclosure: No positions