September 30 1997 Anatole Kaletsky in The Times

Brown's poisoned cocktail

As Tony Blair and Gordon Brown bask in the adulation of the party faithful at Brighton, a possible clash between the next door neighbours at Downing Street is looming into view.

At stake, predictably, are the issues that have poisoned the relationships between so many previous Prime Ministers and Chancellors of both parties ­ the explosive cocktail of

sterling and Europe.

We may never know whether Mr Brown's political office was responsible for placing last week's story about an imminent announcement on joining European monetary union. But the ambiguity of the Treasury's response ­ the story was dismissed as "pure speculation", but was not

specifically denied ­ suggests that Mr Brown was not displeased to see these rumours circulating in the media and gaining the financial markets. What, then, are Mr Brown and

his friends really up to? Let us engage in some "pure speculation".

First and foremost the Cabinet's Euro-enthusiasts are trying to create unstoppable "momentum" (a favourite term of new Labour politicos) for British membership of EMU. Although

Mr Brown would probably like to join the single currency as quickly as possible, the precise date of joining is less important than the sense that membership is inevitable. Once this conviction becomes sufficiently widespread, it becomes a waste of time to debate the principles of the single currency project or the costs and benefits of Britain staying out in the long term. Inevitabiilty has the further advantage of making the Euro-phobic Tories seem to be living on another planet ­ a party strictly for the lunatic fringe.

Last week's FT story fits perfectly with this plan. By introducing the idea that Britain might commit itself to EMU membership even before the next general election, the Treasury can hope to achieve numerous objectives. Until last week, it seemed likely that the new Government woud stick to a slightly modified version of John Major's "wait and see" approach. Britain would try to help its partners make EMU sucessful and would keep open the option of joining sometime in the indefinite future, provided the economic conditions were right and the project was going well. This seems to me to be still the most likely formulation for the Government to announce later this year.

After last week's stories, however, expectations may have been raised sufficiently for a statement like that to be represented as a "setback" for British membership of EMU

and an indication of waning commitment to Europe. As a result, Mr Brown and his allies now have a new argument for pressing the Prime Minister for a stronger line, perhaps even

including a commitment to join by a definite date, such as 2002.

The stories about early EMU membership also have obvious economic attractions for Mr Brown. By persuading the markets that Britain's exchange rate will be, say, DM2.65, Mr Brown may hope to undo some of the damage caused by his decision on Bank of England independence, which directly led to the uncomfortable strength of the pound.

Unfortunately for the Government, however, the markets are not stupid, however excitable and credulous they may seem in the short-term. It may soon become apparent that Britain will not, in fact, join EMU before the next election, if only for the simple reason that Tony Blair is not mad enough to jeopardise his entire political career ­ and with it the entire future of the Labour party ­ by calling a referendum which he could never be sure of winning, however high his government may stand in its own private polls.

Once markets realise this, they will calculate that there is no chance of Britain joining EMU before the next election ­ meaning in effect 2002. From this they will conclude that nothing that is said or rumoured today about Mr Brown's views on exchange rates will bear the slightest relationship to where the pound will be by the time Britain actually joins.

Once this becomes apparent, the pound will rebound. In the long-run, therefore, the Treasury will have achieved nothing in its attempt to manipulate the market. If, however, the EMU rumours succeed in creating a temporary bout of sterling weakness, the Bank of England may well feel obiged to respond by raising interest rates, thereby adding to the pressure on industry, since these interest rate hikes are unlikely to be reversed promptly once the pound's strength

revives.

If all this comes to pass it will raise a fascinating political question. Will Mr Blair blame his Chancellor for having mismanaged sterling and damaged the economy by trying to bounce him into EMU? Or will Mr Brown manage to persuade the Prime Minister into his half-heartedness

towards EMU is no longer sufficient and that the economic difficuties require Britain's commitments to be ratched up?

Whichever the answer turns out to be, it will not contribute to the unity of the government or the warmth of relations between the two neighbour in Downing Street.