Finance officials are generally not known for extravagant displays of emotion but it would be surprising if the recent shift in Britain's attitude towards EMU has not provoked at least a smile or two in the Department buildings on Merrion Square. The suggestion made by "a senior UK cabinet minister" that Britain would enter EMU shortly after it commences is unquestionably good news for Ireland. It is a virtual certainty that Ireland will be one of the initial participants in EMU and, whether you are in favour of the single currency or against it, there is no doubt that it will be better for the country if Britain participates as well.
Since last Friday's report of the leaked comments, the British Prime Minister Mr Tony Blair and other senior Labour figures have denied that Britain's EMU policy has changed. Nonetheless, there can be little doubt that Britain will adopt the single currency within two or three years of its commencement on January 1st, 1999. This firm assertion does not rely on last week's report alone. History and realpolitik also support the view that Britain's use of its Maastricht opt-out will be short lived.
Firstly, Britain's approach to every major European initiative since the second World War has followed a consistent pattern: scepticism and non-co-operation prior to establishment, followed by eagerness to participate once the project has got under way. Thus far, Britain's approach to EMU has displayed a religious observance of this tradition. There is no reason to believe that it will not fulfill the second part of its custom.
Secondly, the Labour government's stated desire to place Britain at the heart of Europe is incompatible with a policy of non-participation in EMU. If Mr Blair's hope to play a leading role in Europe is to become anything more than a vague aspiration, Britain cannot remain outside the EU's primary project for long.
This is good news for Ireland. Once Britain is within EMU, more than two thirds of Irish trade will be conducted in the single currency and the danger of a competitive exchange rate loss to Britain will disappear. Overall, the long-term prospects of Ireland within EMU would be promising and relatively risk free.
In addition to the long-term significance, the realisation that Britain will not remain outside EMU for long has more immediate implications for Ireland: it has, in all probability, brought the pound revaluation debate to an early conclusion. It is now much more likely that the pound will convert to the euro at its existing central ERM parity of DM2.41.
This does not follow directly from Britain's willingness to join. Rather, it results from the Labour government's obvious desire to convert to the euro at a much lower rate than sterling is currently trading.
When Britain joined the Exchange Rate Mechanism (ERM) in 1990, the then Chancellor of the Exchequer, Mr John Major, made the mistake of bringing sterling in at an overvalued level. The consequences of this error are well known and it is not a mistake that the Labour government is likely to repeat.
Were Britain to enter EMU at sterling's current level, it would be a disastrous recipe for the British economy. Boosted by the relative buoyancy of the British economy, sterling is trading at a rate that has left British exporters uncompetitive. All measures of the real exchange rate suggest sterling is overvalued. The International Monetary Fund, for example, provides a measure of relative unit labour costs adjusted for the state of the economic cycle. At the end of July, British relative labour costs were higher than at any time since 1983. Although this measure has declined in line with sterling's depreciation since then, it is still higher than it was prior to Britain's ejection from the ERM in 1992. Sources close to Mr Gordon Brown, the Chancellor of the Exchequer, suggest he is acutely aware of the dangers of converting to the euro at an overvalued rate and that he is keen to push sterling lower before joining. It is said that he is considering a conversion rate of DM2.60 or lower.
Moreover, forward exchange rates for sterling against the deutschmark (derived from the current exchange rate and the interest rate differential between Britain and Germany) suggest that foreign exchange traders believe sterling will convert to the euro significantly below its current level. The forward rate for sterling-deutschmark to January 1st, 2001 - the most likely British entry date - is some 20 pfennigs below its current level. On this basis, one could conclude that an entry rate of DM2.65 is already being discounted.
In the likely event that sterling continues on a downward path, the inflationary danger for Ireland of converting at its current central ERM rate would be much reduced. There would remain some danger of an acceleration in prices but, with Ireland's inflation rate standing at only 1 per cent, the lowest in Europe, a revaluation of the pound would present a much riskier option.
Kevin Daly is treasury economist at Ulster Bank Markets. The views expressed here are personal.
