Although Britain has a right to "opt out" of monetary union, due to launch in 1999, the Government is taking a full part in talks on the preparations should it decide to opt in.
In discussions at the European Monetary Institute in Frankfurt, where all European Union central bank governors are drawing up the EMU masterplan, Germany is insisting that all countries which join the single currency adopt German monetary policy instruments, including minimum reserve requirements, regarded by some in the financial community as a quasi tax on banks.
The German system means that each bank must hand over a portion of its deposits, to be held by the central bank without interest, as a means of controlling inflation. Hans Tietmeyer, president of the German Bundesbank, argues that it is the most effective system for keeping prices stable. Britain believes adopting the continental monetary policy tools would be extremely costly and could scare away big commercial banks from London.
The threat to the City is certain to feed British Euro-sceptic fears about monetary union. Under the Maastricht treaty, the masterplan for monetary policy must be agreed by 1996, ahead of the British election, which has to take place by mid-1997.
According to senior banking sources in Frankfurt, Eddie George, governor of the Bank of England, is blocking the plan and discussions have reached an impasse. There are fears in Frankfurt that Britain may veto the masterplan, thereby holding up the move to monetary union. The Bank of England says it strongly opposes the German system, claiming that options are still open. However, in a speech this week Mr Tietmeyer made clear that Germany will insist on a system of minimum reserves. Describing how Germany wants the European Central Bank to operate, he mapped out a vision which closely resembled his country's own central bank.
"It is a fundamental clash of philosophy over monetary policy with Germany at one end and Britain at the other," says Graham Bishop, European affairs adviser at Salomon Brothers in London. "If high minimum reserve requirements are introduced, some banks based in London could move offshore from the EU. It is effectively a tax on banks."
Even EU officials who support monetary union concede that Britain has justified fears. "Many banks have moved to Britain, citing London's favourable regulatory climate. Britain risks losing its status as a financial centre," said a senior economics official in Brussels. "This shows how important it is for Britain to be involved in the heart of discussions on developing monetary union."
The dispute is the most significant split yet between Britain and its European partners over the preparations for monetary union and illustrates how difficult it will be for Britain to agree a European approach to monetary policy, should it decide to join the single currency. The row also illustrates how hard it is becoming for Britain to sit on the fence over joining as preparations get underway. John Major has said there is no urgency for Britain to decide on whether to join EMU, and the Government will wait until the time is right.
It is widely expected that the decision would not be taken until after the next general election. However, although Britain can defer its decision, it is becoming increasingly difficult to put off deciding whether to join in the preparations. In order to be ready - just in case - Britain must start preparing the City, the financial institutions and the public.