Britain will come under pressure from its European Union partners to rejoin the EU exchange rate mechanism, once the government declares its intent to take part in economic and monetary union, according to EU monetary officials. If sterling did enter the ERM it would limit the risks to Ireland of joining monetary union ahead of Britain, as the British currency would only be able to fluctuate within certain limits against the new currency, the euro.
Pressure to join the successor system of the ERM in 1999 will add to the British government's dilemma over EMU. It is especially keen to avoid a repeat of events in 1992, when sterling was forced out of the ERM.
The Maastricht Treaty stipulates two years of ERM membership without devaluation as a qualifying condition for EMU. But Britain and Sweden are disputing whether this clause is legally valid for ERM2, which is due to take over from the existing ERM in 1999. ERM2 will link the currencies of EU countries, which are not in EMU, to the euro.
The British Prime Minister, Mr Tony Blair, is expected to rule out joining EMU at the scheduled launch date in 1999. But he will be under pressure to accompany this statement with a clear signal of Britain's EU commitment.
If he sets a time-frame for a referendum, Britain's EU partners will insist that sterling enter ERM2, at least for some time.
If he leaves the question of EMU membership open, the choice of joining a wide-band ERM would then become one of only a few policy options left for the government to sustain Britain's influence over future monetary policy in the EU.
Either way, the pressure to join ERM2 will be strong. And if sterling is a member of ERM2, then its fluctuations against the euro will be limited, which will limit the risk of Irish membership. The width of the new ERM2 band has still to be negotiated.
The renewed speculation that Britain is warming towards embracing the euro not too long after it starts is continuing to be assessed in financial markets. Yesterday, sterling remained more stable after its recent falls, allowing the pound to hold at over DM2.57, a rate around which market analysts now believe it could hold unless sterling tumbles again.
The exchange rate clause in the Maastricht Treaty has given rise to conflicting interpretations.
The European Commission and the majority of EU central banks insist on formal ERM2 membership as an entry requirement. The Bundesbank said yesterday: "It is still (our) position that future members should be part of the system."
At a recent meeting of finance ministers, Mr Hans Tietmeyer, Bundesbank president, insisted that ERM currencies should, in addition, observe relatively narrow fluctuation margins before taking part in EMU.
EU monetary officials indicated there may be some flexibility, implying that a period of less than two years could be deemed sufficient.
