Labour's election victory signalled the beginning of a fierce and protracted battle on euro entry, one of the most important issues facing the UK. The British public remains hostile to joining and, given the huge political costs for the prime minister of losing a referendum, he will be very cautious before making a recommendation.
The government's policy, formulated by Gordon Brown in October 1997, was politically astute. It expressed support for the principle of joining a 'successful' single currency and made the decision conditional on satisfying, 'clearly and unambiguously', five economic tests. Also, largely because the subject generates strong emotions, it postponed the decision to the next Parliament.
The five tests relate to: sustainable cyclical and structural convergence between the UK and the eurozone; sufficient flexibility, in Europe and Britain, to deal with problems that may arise; and benefits from joining in terms of investment, employment and financial services.
Although these conditions are expressed in technical language used by professional economists, most of them are in fact highly subjective. Given the complexity of the subject, it is clearly impossible to make an objective assessment that is 'clear and unambiguous' or, indeed, to determine whether the euro is a 'successful' currency. Moreover, although the government states that there are no 'overriding' political objections to euro entry, there can be no doubt that political considerations will be as important to its decision as economic ones.
Joining the euro will produce benefits by reducing exchange rate risk and transactions costs for both businesses and individuals. It will stimulate trade, make the single European market more effective and, by increasing competition and transparency, help to lower prices and interest rates. The arguments for entry are further strengthened by the potential damage to our foreign investment, the City of London and our political influence, if the UK stays outside the euro for a long time.
However, there are equally powerful arguments for not joining. Transferring authority for setting interest rates to the ECB means accepting a monetary policy that may not always suit Britain's specific needs. Giving up the ability to either devalue or revalue our currency is risky - if interest rates are too high or the currency too strong we could face recession. Conversely, if interest rates are too low or the exchange rate too weak, there could be higher inflation.
It is widely accepted that we are now much nearer cyclical convergence, the most measurable of the five tests. This is because the interest-rate gap between the UK and the eurozone has shrunk considerably, and the pace of growth is slowing in both economies. However, Gordon Brown may still hesitate if sterling falls sharply before we join, because economic stability may be put at risk.
Losing a referendum could be a political disaster, and changing public opinion is a formidable task. In recommending entry, the government may also endanger its reputation for economic competence. Since joining the euro is bound to inflict pain occasionally, it cannot be justified on economic grounds alone. Membership must ultimately be a political act, linked to a vision of Britain's wider European destiny.