If British exporters have trouble now, think what would happen if the euro surged after we joined it

For Tony Blair, the European Union summit in Barcelona was the council of merde. The TUC general secretary lambasted him for stitching up unholy deals with the moneybags right of Italy to strip British workers of a fig leaf of employment protection. And then proper French socialists manned the barricades to keep out fully fledged competition from European energy markets.

There will soon be a new Big Tent, filled with trade unionists and business people united in their scorn for the government's European policy, if divided in their views of Blair's beloved "flexibility".

You want a microcosm of the government's achievement in Europe? RWE, a lumbering and inefficient German utility, is scoffing Innogy, one of the better-run energy companies in the UK. Once Innogy is in the belly of the Germany beast, the overwhelming majority of British energy groups will be foreign-owned. Which would not matter at all, if the residual UK utilities could go shopping in Europe. But Blair failed to get them past the liveried doorkeepers.

One of this government's slightly weirder beliefs is that the argument in favour of joining the euro would be won if only the eurozone would come over all flexible. Hmmm. If winning the referendum is his aim, Blair would be better off sending Alastair Campbell on a mission to Britney Spears to persuade her to endorse the great European project.

This flexibility malarkey is also at the heart of the Treasury's five tests on whether it is safe to join the eurozone. They are Gordon Brown's "spectacles, testicles, wallet, watch and - oh - testicles again". And there is another question that needs to be answered in each element of the five-part catechism: at what exchange rate could and should we sign up?

Indeed, the pro-euro stance of the Prime Minister is widely misunderstood. For him - and for Gordon Brown, in spades - there is one thing worse than not joining the single currency. It is to join at the wrong exchange rate. An economic crisis caused by sterling locking with the euro at a level that wreaked yet more damage to exporters is one of the few potential disasters that could cost Labour the next election (going to war with Saddam may well be another one). If you want to see why, have a glance at this week's results from Corus, the made-over British Steel. Losses last year from the manufacture of carbon steel were a tidy £446m - and quite a lot of that bright red ink was the fault of sterling's excessive strength against the euro.

Inevitably, therefore, the TUC, the CBI and an industry of economists have dedicated themselves to determining the appropriate sterling/euro rate for joining. But I am going to be really beastly by not quoting a single one of them. For the sake of argument, I will take it as read that some genius inside Whitehall will find a way to get us into the single currency at the optimum rate.

At present, monetary union membership rules appear to make it impossible for us to have any real control over the price of sterling at entry and would seem to consign us to joining at a dreadfully uneconomic rate. But I am going to assume that some political solution can be found to this difficulty. And I am also going to assume that the government has the ability to determine the optimum rate - one that is neither too deflationary nor too inflationary - with scientific precision.

Surely, in my forex Utopia, Blair should plunge head first into the eurozone. I fear not. There is another exchange rate vital to the long-term economic performance of the UK once inside the eurozone: the euro/dollar rate. We ignore it at our peril when deciding whether to join.

The euro is profoundly undervalued against the dollar. Even the European Central Bank has said as much. At some point, its value will rise sharply, although the magnitude and timing of the correction are impossible to predict. But when it comes, it may well be a financial tsunami. According to so-called momentum analysis, carried out by my colleague Chris Chaitow at Collins Stewart, the euro could rise as much as 30 per cent if it breaks through $0.91.

Now think about what would happen if sterling joined the euro at my optimum pound/euro rate but the euro then surged ahead by anything like 30 per cent against the dollar. The competitiveness of British dollar-denominated exports would be hammered.

Official statistics show that 29 per cent of British exports of goods and services are priced and sold in dollars. They would become a third more expensive. Meanwhile, 34 per cent of imports are dollar-denominated, so they would become a third cheaper. If you make steel in South Wales or microchips in Cambridge, such price swings would be scary.

So we cannot contemplate joining the euro until we feel that it has risen to a sustainable level. And the Treasury has already taken this on board - which is one of the unspoken reasons why it is more bearish than Downing Street about the prospects for joining in the short term.

If the dollar cracks by the end of the year, there is a chance that the government can make a decision to join by the de facto deadline of June 2003. And if the euro remains dismally weak, the prospect of UK membership in the lifetime of this parliament recedes. Blair has no option but to hope and pray that the tarnished reputation in international markets of Wim Duisenberg and the European Central Bank is soon mended. But it would be a sucker bet to stake the reputation of his government on it.

Robert Peston is editorial director of QUEST ; www.csquest.com; e-mail rpeston@csquest.com