Bank of England Governor Mervyn King criticized EU leaders for loosening the fiscal rules that underpin the value of the euro, saying restrictions on government spending in the region lack "discipline."
EU leaders on Wednesday agreed to allow finance ministers to permit deficits over 3 percent of GDP in some cases. The rules permit finance ministers to consider "relevant factors" such as slower growth or Germany's costs to rebuild its ex-communist east.
"The finance ministers have driven a coach and horses through the stability and growth pact," King told a parliamentary committee in London on Thursday. "My central bank colleagues in Europe are seriously concerned; indeed, I think dismayed would be a better word."
The European Central Bank (ECB) has said deficits may push up inflation and interest rates. Standard & Poor's has warned the easier constraints may lead to bigger deficits, lower credit ratings and higher borrowing costs for all EU nations.
Speaking in Parliament later on Thursday, British Prime Minister Tony Blair defended the measures and said his country wanted more changes to allow further flexibility in the rules.
"I do think that the greater flexibility in the stability and growth pact that was agreed makes sense," Blair said in response to questions in the House of Commons. "You have to have the right set of rules. There are changes that we want to see to the stability and growth pact."
King said that strict rules are needed to assure the stability of the euro and that nations using the currency need to exercise "collective fiscal discipline."
"Whatever word you use to describe these changes to the pact, it isn't discipline," King told the Treasury Committee of the House of Commons.
On Wednesday, Luxembourg Prime Minister Jean-Claude Juncker said the EU may allow member nations to adopt the euro without adhering to a limit on government budget deficits.
King's comments echo European Central Bank policy makers, who have said interest rates may need to be boosted to compensate for the relaxation of fiscal policy. Nout Wellink, one of 18 ECB policy makers and head of the Dutch central bank, said on Wednesday the changes will make it more difficult to predict budget deficits.
Shortfalls may become "bigger and less compatible with monetary policy and eventually lead to less growth and higher interest rates," he said.