Blair's Euro Dilemma

Can he coax Britons into the single currency?

Rod Turner runs Whale Tankers Ltd., which employs 155 people in the Midlands town of Solihull building custom truck containers to haul toxic waste. The high exchange rate of sterling, which has risen 14% against the euro since the start of last year, has turned up the heat on Whale and many other British manufacturers. Still, Turner thinks joining Europe's single currency to escape effects of the strong pound would be a mistake. "We are doing very well outside," he says. "We have the lowest taxes, lowest unemployment. Why take this leap into the unknown?"

Prime Minister Tony Blair would like to make that leap--if he thinks conditions are right. Fresh from a huge reelection win on June 7, Blair wants to go down in history as a great modernizer. And he thinks securing Britain's place in Europe is key to his legacy. He hears from Continental leaders and pro-European advisers that unless Britain adopts the single currency, it risks becoming marginalized outside an increasingly influential European Union. Yet Blair knows he would have to spend heavy political capital to persuade skeptical Britons to join. "Blair has a real dilemma," says Ruth Lea, policy director of the Institute of Directors, a business group. "He wants to be at the heart of Europe, but he clearly can't be unless he goes into the euro."

Not surprisingly, the cautious Blair hasn't yet decided to give the euro a thumbs up. He has promised to make a decision within two years and to hold a referendum if he recommends joining. Winning such a vote is a daunting challenge. Public sentiment against adopting the euro is running at between 2-to-1 and 3-to-1. "Our guess is that Labour will not be able to shift public opinion in favor of European Monetary Union entry early enough for Blair to call a referendum in the next couple of years," says Michael Saunders, an economist at Schroder Salomon Smith Barney in London. By then, the window will have likely closed until the next parliamentary elections.

What's more, the economic case for entry into the euro is not overwhelming. The euro's advocates argue that the high sterling is killing manufacturing and threatening foreign investment. But Britain's economic circumstances don't help them. Over the past five years, Britain has averaged 2.8% economic growth, vs. 1.8% for Germany. British unemployment, at 3.1%, is the envy of Europe. And Britain leads Continental rivals in attracting foreign investment. There is also no evidence that being outside the euro zone has damaged the City of London. Having a corner on the market for sterling products may have given City financiers an edge to break into other markets.

While some British economists think Britain could adopt the euro without major disruption, others disagree. David Hillier and Adam Law, economists at Barclays Capital Inc., the investment banking unit of London's Barclays Bank, argue in a recent report that "the U.K. [cannot] live comfortably with euro interest rates," which are set by the European Central Bank. For example, Hillier says that if today's euro zone interest rates of 4.5% were applied to Britain, inflation, now about 2.4%, would leap by up to one percentage point. "Our economy responds differently to changes in interest rates," he says. Britain's more flexible labor and goods markets, and the higher percentage of adjustable-rate loans taken out, make its economy more sensitive to rate changes than those on the Continent.

SKEPTICS. Blair will be closely following the bitter battle for public opinion. The pro-euro campaign called Britain in Europe has enlisted such heavyweights as Unilever PLC Chairman Niall FitzGerald and British Airways PLC Chairman Colin Marshall. These chieftains are getting more vocal on the euro. "A lot of multinationals have been giving the government the benefit of the doubt; if they see prevarication they will move investment elsewhere," says Chris Haskins, chairman of Northern Foods PLC, a Hull wholesaler.

The anti-euro camp, known as Business for Sterling, is less heavy on Establishment stars, but it is strong among people in small and midsize businesses. And some well-regarded young chief executives have been attracted to the "no" camp. One is Simon Wolfson, the 33-year-old chief executive designate of clothing retailer NEXT PLC. "It is not possible to effectively manage the whole economy of Europe," he says. "Certain regions of Europe will require higher interest rates to control inflation, while others will require lower." Europe's current performance--with low growth in Germany and inflation heating up in Ireland--reflects that, he adds.

Should Blair determine that the omens are right to push on the euro, a likely referendum date would be the fall of 2002. But Blair will have plenty of persuading to do--first of all with Brown, who is more skeptical about the euro than Blair. Then Blair would have to negotiate favorable terms of entry for Britain. Most analysts say sterling would have to come down at least 10% from its present level--one reason the currency has plunged recently.

Blair would also have to persuade Europeans to be accommodating about other details for Britain's entry. While politicians are unpredictable, there's a good chance the Europeans would oblige. Their own experiment with the euro might be a better bet with pesky sterling finessed. But Blair has some finessing of his own to do first.

By Stanley Reed in London

    Before it's here, it's on the Bloomberg Terminal.