Mr Major cannot expect much relief from the real world. The CBI quarterly survey showed that businesses had once again been disappointed by their sales and that stocks had built up. Executives may well return from the holidays and decide that they have to embark on a new attack on costs, which will involve further production cuts. If so, there could be a second leg of the downturn in the autumn.
Nor is there any sign of the cavalry coming from the Continent. The flood of money out of the dollar into the mark has left sterling down against the German currency and has removed all possibility of cutting UK interest rates unless there is a German rate cut. But Helmut Schlesinger, the Bundesbank president, held out little hope of early interest rate cuts in his Guardian interview last week. Indeed, it would have been surprising if he had expressed more hope, since the council has only just raised the discount-rate floor for money market rates.
True, the Frankfurt consensus - that there will be no interest-rate cuts before the end of the year - may prove to be too pessimistic. There are signs of slowing demand. Norbert Walter, the savvy Deutsche Bank economist, predicts that German rates may fall gently next month, leaving the main money market rates down by 0.4 per cent by the end of the year.
Even a September cut would not be much consolation as Dr Walter believes that the decline will be slow, because the Bundesbank fails to take account of the one-off nature of the VAT increases boosting prices and because underlying growth is more robust than the recent strike and holiday-depressed figures have suggested.
Meanwhile, there is a further possible threat to British interest rates if the French referendum on 20 September rejects the Maastricht treaty. Mr Major has asked for a damage- limitation exercise to be prepared. Although the polls continue to point to a 'yes', the 'no' campaign is clearly gaining ground. It may be altogether closer than most analysts have supposed.
If France rejects Maastricht, the ERM will come under immediate pressure. The markets will no longer expect governments to try so hard to bring their inflation and budget deficits down. The Italians may well be forced to devalue. After all, their interest rates have already been frogmarched up to the crisis level of 17 per cent. Britain would soon be in the firing line, too, with the markets insisting on higher interest rates to cover the increased risk of a devaluation against the mark. Even if German interest rates come down, British interest rates might have to go up.
All of which cannot help but reinforce the view that Europe's monetary problems would be eased substantially if progress towards economic and monetary union were more rapid. The International Monetary Fund's study of the run-up to EMU, leaked in the Paris paper Liberation on Tuesday, was reported as showing that Maastricht had a secret cost: a short-term fall in output as countries reduced their inflation to the level necessary to fulfil the Treaty's convergence conditions.
The detail, however, is more subtle than the coverage implied. The graphs show the path of output for each of the main EC countries on two different scenarios: in both scenarios, there is a short-term cost as countries comply with the convergence conditions. Italy is hit most severely because it has to reduce a budget deficit of more than 10 per cent of national income to less than 3 per cent: this involves spending cuts and tax increases, which depress the economy.
The difference between the two scenarios is caused by what happens to interest rates: in the first scenario, the financial markets are convinced that EMU will happen. They allow high-interest-rate countries like Italy to cut their rates to much nearer Germany's. The result is that the depressive effects of cutting the deficits are substantially offset: the average drop in Italy's output between 1993 and 1996 (compared with unchanged policies) is reduced from 2.8 per cent to 1.1 per cent.
Countries that already have relatively low inflation and deficits do not suffer. Even if the markets do not believe in EMU, Britain's output is only 0.2 per cent below the path on unchanged policies. On scenario 2, there is no cost at all. Indeed, the differences for France, Germany and Britain are all within any conceivable margin of error. It is the experience of Italy that dominates the picture.
But that in turn begs the question of whether the Italians can really continue their rake's fiscal progress. In reality, they cannot. The baseline case used by the IMF is flawed, because it assumes that Italy's present policies can continue unchanged. As the IMF itself points out, it is arguable that Italy would cut its budget deficit whether or not it was trying to meet the Maastricht targets. It would therefore suffer some of the effects shown in scenario 1 in any case. Indeed, credible progress towards a single currency may help the Italians by cutting interest rates.
The IMF study does, though, bear out one of the implications of the Commission's own research in One market, one money into EMU: the costs of cutting inflation and deficits occur quickly, while the benefits of lower interest rates take time to come through. With any such policy proposal, it surely makes sense to accelerate the timetable as much as possible, since the benefits would then be brought forward to offset the costs.
But Germany's fear of a leap into the unknown has caused the timetable to be delayed. The Maastricht treaty says that it is not possible to move to a single currency until the beginning of 1997, and then only if everyone is ready. A smaller group cannot go ahead before the beginning of 1999.
There is no real reason why France, Germany, Britain and the Benelux could not go ahead almost immediately. The British Government would certainly find a rapid move to a single currency politically difficult, but the economic advantages for Britain are, ironically, particularly great.
After all, the high German interest rate levels which result from the ERM are least appropriate for the most depressed and most indebted economy.
A monetary authority for the whole area would set interest rates according to the depressed economic conditions of Britain, France and the Lowlands as well as the still inflationary conditions of Germany. They would certainly be several percentage points lower than our present ones. Anyone for a quicker EMU?Reuse content