Although home to some highly sceptical views on European Monetary Union (EMU), the UK is nevertheless poised to meet the Maastricht criteria for a single currency. Inflation and long-term interest rates are, respectively, within 1.5% and 2% of the EU's best performers, while outstanding government debt is below 60% of GDP. The one black spot is the budget deficit, but with taxes increasing further this is set to fall below 3% of GDP in the next few years. These factors will determine whether the UK is able to join the EMU. However, says Schroder Economics, a more appropriate guide as to whether this would be economically beneficial may be found in comparison with the likely core group of countries, particularly Germany.
Under EMU, the UK would not only give up the pound sterling but also control of interest rates, which would be established by the new European Central Bank. If monetary conditions were out of line with those elsewhere, then the country could end up with an inappropriate range of rates. The relatively low correlation between British and German economic cycles (see chart) suggests that the UK might need to retain freedom to set interest rates, or to change its exchange rate.
Taking into account, in addition, the UK's greater sensitivity to short-term interest rates due to high levels of variable rate mortgage debt, then membership of the EMU could clearly put a strain on the economy. This means that, aside from the narrow criteria set out at Maastricht, the UK needs to lift its trade with the rest of the EU to a higher level. It also needs a greater proportion of outstanding debt at fixed, rather than variable, rates before dropping the pound.