LONDON (AFX) Bank of England governor Eddie George said the current weakness of the euro is "a potentially serious obstacle" to the UK's early entry to the single currency.
In a speech for delivery at the Lord Mayor's Mansion House dinner for bankers and merchants, he said he therefore welcomes "the considered and cautious approach" to assessing the viability of euro entry that UK chancellor of the exchequer Gordon Brown has outlined. George said most people agree that sterling's exchange rate, on entry to the euro, "would need to be substantially lower than our present rate, which few would regard as sustainable in the medium and longer term".
He said this could come about in two ways.
"If, achieving what was considered to be an appropriate entry rate against the euro... involved a substantial depreciation of sterling's overall, effective, exchange rate (that's to say sterling's rate against other currencies generally), that would be bound to put strong upward pressure on our domestic rate of inflation," he said. "That would not only destabilise our domestic economy, it would also cause the intended euro-entry rate to appreciate in real terms, with adverse implications for our competitiveness within the euro zone," he said.
"These effects would clearly be difficult to contain given the constraints on both our interest rate and the exchange rate as we moved towards entry, and very difficult to reverse once we were inside the single currency area," he said.
George said this obstacle would diminish to the extend that the euro recovers against other currencies "as at some point it surely must".
He said that in that case, sterling might weaken against the euro but it could strengthen against the dollar and other currencies, leaving the overall, effective exchange rate closer to its current level.
"That would have less impact on our domestic rate of inflation," he said.
On monetary policy, George said the BoE's policy of encouraging the growth of private sector consumption to try to keep overall demand in the economy growing in line with potential supply is not without risks.
He said this approach involves accepting a growing imbalance between the internationally-exposed and domestically-oriented sectors, at least while the dampening external influences persist. "If we do not accept that, then overall demand and output would be lower, and inflation would tend to fall further below target. But the imbalance cannot continue to grow indefinitely," he said.
"At some point, the elastic is likely to break - quite possibly through a sharp exchange rate adjustment. And at that point, having deliberately stimulated domestic demand growth, we would need to rein it back," he said.
George said however that the BoE could then find its momentum hard to stop.
"I am not suggesting that we are necessarily approaching that point. Domestic inflationary pressures, including wage pressures, have so far remained reasonably subdued and it is crucially important that that should continue. But it does explain our caution in moving rates down," he said.