International Corporate Finance Info

3.2.5 Loss of monetary policy autonomy

Britain’s monetary policy autonomy is reduced by joining a single currency. The flexibility to set interest rates to meet their own objectives will be lost by joining the EMU. The ECB will attain a permanent transfer of domestic monetary sovereignty through Britain’s entry to the Euro area.

Scope is limited for fiscal policy to cushion the effects of economic shocks thus being an effect in different ways to different countries which is as a result of the pact of fiscal stability that was signed by members. National budget deficits to 3% are limited by this pact and it is difficult for international transfers to take the strain because the EU budget isn’t big enough. (Infocheese, 2008)

Partly because of the high scale of owner-occupation on variable- rate mortgages, Britain is more sensitive to interest rate changes as compared to the EU countries. Britain is required to have more flexibility in labor markets as well as housing markets in order to join a currency union with little monetary flexibility. For owner-occupation, the rented housing sector is too small to be a good substitute therefore the structure of housing finance has to be changed. For investment projects, British companies heavily rely on debt finance for payment rather than through capital markets where new equity (shares) will be issued. As a result, The Bank of England keeps its interest rates high as compared to the ECB. (tutor2u, 2011)

Figure 6: Base interest rates for the Euro zone and the UK

Source: Adapted from (Riley, 2006)