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RIGA (Reuters) - Small Baltic state Latvia decided on Monday to apply to join the euro zone next year, a sign of the faith in the currency which still exists in eastern Europe after three years which have threatened the project.
Latvia pegged its currency to the euro after joining the European Union in 2004. It and Lithuania, which pegged in 2002, stuck with the links through two years of turmoil after 2008 which saw their economies shrink by up to a fifth.
Both have recovered strongly - in Latvia's case helped by an EU and IMF bailout in 2009 - and have been on track to seal membership of the 17-member club after neighboring Estonia joined successfully in 2011.
Small and limber economies, Latvia and Lithuania should slide more easily into the currency bloc than larger states like Poland and the Czech Republic and have remained keener on joining throughout the banking and debt crises.
Many Latvians' mortgage loans are in euros meaning a switch would decrease currency risk and most see the currency as a lesser long-term risk than the lat. They are also keen to entrench their links with western Europe to keep former imperial master Russia at arms length.
But while the country's leadership is keen on the project, polls show much of the population are worried that a currency switch will drive prices higher and take control of the economy out of Latvian hands.
To join the euro zone, Latvia needed to ask for an assessment by the European Commission and European Central Bank of its readiness to switch currency and the cabinet of ministers took this step on Monday.
"This is a day that will enter Latvia's history," Finance Minister Andris Vilks told reporters when he, Prime Minister Valdis Dombrovskis and central bank chief Ilmars Rimsevics signed the application.
The application will be handed over in Brussels on Tuesday. A report on Latvia's euro hopes will be prepared by the European Commission and the European Central Bank. Finance ministers are expected to take a final decision in July.
Latvia says it meets all the economic criteria needed to be accepted into the euro zone. The criteria relate to levels of debt, deficit, inflation, long-term interest rates and having a stable peg to the euro.
Dombrovskis said after the signing that the euro would benefit Latvia in terms of increased investment, lower currency exchange costs and would help ease social ills.
He expects public opinion will swing behind euro accession as the entry date gets closer and has no plans for a referendum.
Enthusiasm for the euro waned across much of eastern Europe after Greece's problems emerged in 2009 and drove the currency bloc into a series of sovereign bailouts which has split its members economically and raised questions of its broader viability.
Much of those nerves have eased for now on the back of strong action by the European Central Bank last summer and membership has inched back onto the agenda in the region's biggest economy, Poland.
The Czechs and Hungary remain far more skeptical while Romania and Bulgaria are still far from fulfilling the Maastricht criteria for joining.
Latvia kept its peg to the euro even when some economists said a devaluation would have helped ease its downturn in 2009 and the government had to slash public sector wages and hike taxes instead.
Despite its current relatively high growth rates, at 5.1 percent year-on-year and 1.3 percent quarter-on-quarter in the last three months of 2012, the country remains one of the poorest countries in the EU along with Bulgaria and Romania.
Lithuania has said it was considering adopting the euro in 2015 or 2016.
Reporting by Aleks Tapinsj, writing by Patrick Lannin; Editing by Alistair Scrutton