By Michael R. Sesit
Staff Reporter of The Wall Street Journal
LONDON -- Can British pollsters and bond traders be dead wrong on the euro?
Most public-opinion polls suggest Britain is unlikely to adopt Europe's single currency soon. Bond-market projections of where interest rates are headed suggest the same thing, and foreign-exchange traders also appear to be highly dubious. Yet some hedge funds and other speculators are placing big bets that the United Kingdom will eventually forsake the pound sterling in favor of the euro.
"We have a market that doesn't believe in it yet," says Ed Eisler, head of European interest-rate products at Goldman Sachs in London. "But if you are willing to put a wager on it happening over the next two to three years, the market is paying you quite good odds."
Betting that Britain will adopt the euro is a gutsy call. The ruling Labor Party has said that by mid-2003 the U.K. Treasury must first make an assessment of five economic tests designed to show whether joining the euro would be good for British investment and jobs. If that is positive, Prime Minister Tony Blair has promised a referendum on whether to join the euro.
In a poll conducted by NOP for Barclays Capital, 57% of the respondents said they would vote against replacing the pound with the euro, if a referendum were held today; 28% said they would vote yes, and the rest either said they wouldn't vote or were undecided.
If the government said the U.K. had passed the five tests and recommended joining the euro, the "no" votes fall to 44%, and the "yes" votes rise to 39%. A big problem for euro supporters is that joining the euro isn't a big concern for the British public. While 48% of the poll's respondents said the government should make health a priority, only 1% said the government should make joining the euro a priority.
"Investors are becoming inured to statements from the prime minister and his minions, testing popular sentiment toward the single currency," says Stephen Lewis, chief economist at Monument Derivatives in London. "Nothing much seems to be happening in terms of practical preparations for the euro. . . . Mr. Blair's drive for a referendum lacks conviction."
If Britain decides to adopt the euro, British interest rates would have to roughly converge with German government-bond rates, which set the benchmark for the euro zone. Thus, yields on long-term British government bonds, or gilts, would rise.
Currently, the yields on British and German bonds maturing in 15 years are about the same. But the market for contracts that allow people to bet on the future level of interest rates implies that 15 years from now, 15-year interest rates in the U.K. will be 1.20 percentage points below equivalent euro rates. "That tells you that the market isn't attributing a high probability to an early U.K. entry," Goldman's Mr. Eisler says.
What's more, it is generally assumed that if the U.K. adopted the euro, it would do so at a much weaker exchange rate than the current 61.20 pence to the euro. That's because a strong pound has damaged British industry by making its goods more expensive relative to those of its major trading partner, the euro zone.
That exchange rate would be subject to negotiations between Britain and the 12 euro-area countries, but it is generally assumed that the rate would be between 67 and 75 pence to the euro. Yet the foreign-exchange options market implies a 25% to 30% probability of the euro rising to 67 or 68 pence in two years. "That," says Mr. Eisler, "essentially tells us that the market doesn't think the U.K. joining the euro is very likely to happen."
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Yesterday's Market Activity
Heightened strife in the Middle East drove traders to buy Swiss francs, triggering stop-losses in the pound and euro that forced the dollar into a sudden tumble.
The yen was hardest hit, however, plagued both by dire economic news from Japan and its lack of status as a stable currency in uncertain times.
Late yesterday in New York, the euro was at 88.06 cents, up from 87.34 in Tokyo and 87.16 Friday in New York. The dollar was at 133.39 yen, up from 133.35 yen in Tokyo and from 132.77 Friday in New York. The dollar was at 1.6619 Swiss francs, down from 1.6823 francs Friday, while sterling was at $1.4403, up from $1.4258 in New York Friday.
Beyond Middle East turmoil, an underlying trend in the market is that foreigners have been moderating their purchases of U.S. assets, said Marc Chandler, chief currency strategist at HSBC New York.