Pound left to go its own way

Bank will not use interest rates to rescue struggling exporters, insists Eddie George

The Bank of England has dashed the hopes of British manufacturers that it will use its new power to set interest rates to ease the burden of a strong pound, which has been crippling exports. It has also questioned the wisdom of using fiscal policy to manage the exchange rate but has hinted it believes sterling's strength is only temporary.

Eddie George, the Bank's Governor, said at a press briefing: "We have a strong exchange rate and that is very uncomfortable for the export sector. But are we to risk destabilising the three-quarters of the economy which is not affected in order to provide protection for that sector of the economy which is?

"It is very easy to say the exchange rate is causing difficulties in the export sector, and that is true, but in this situation you have to try and balance things as best you can, particularly if you think the influences which are impacting on exchange rates are unlikely to persist."

Mr George believes that sterling's strength is in part due to cyclical factors, because Britain is at a higher stage in the economic cycle than continental Europe and Japan. He also thinks it is linked to concerns about economic monetary union. With Britain unlikely to join the first wave of a single currency the pound is protected from market fears that the EMU process is being undermined because it is driven by politics rather than economics.

"Those influences will not last forever," Mr George said. "So it would be unwise to effect a destabilisation of the economy if you think that over time the exchange rate problem will ease." A string of companies have warned that their profits will be hit by the strong pound. Last week, British Steel wrote to government ministers and MPs warning that the strong pound was putting 8.5 million jobs at risk. It re-iterated a call from the CBI for a balanced approach to curbing inflation by using interest rates and fiscal measures.

However, Eddie George was sceptical that fiscal policy was appropriate for influencing the exchange rate.

"I really think that the idea that you can seek to manipulate the exchange rate through fiscal policy is exaggerated," he said. "Fiscal policy has to be set in a medium-term context. It is not an instrument for managing the exchange rate.

"An argument can be made - I say this neutrally, I am not expressing my opinion - that at this stage in the expansion there are arguments that the fiscal situation should be tighter in the medium-term strategic sense. That I think is a sensible argument. I think that the argument that you seek to manipulate the exchange rate by short-term manipulation of the fiscal position is a difficult argument." The Governor's attitude towards sterling's strength has been underpinned by market reaction.

Sterling was buoyed by the announcement on Tuesday that Chancellor Gordon Brown was handing operational independence to the Bank by giving it control of interest rates,which will in future be set by a new monetary policy committee.

Supported by a quarter point base rate rise to 6.25 per cent, the pound rose more than one pfennig to DM2.82. By the close in London on Friday, however, the pound had fallen eight pfennigs from that high to close at DM 2.74.

The Governor rejected accusations that the Bank was insensitive to the demands of exporters.

"There is all this stuff that the Bank is going to run the economy into the ground. That is absolute nonsense," he said. "What we are about is growth and employment, but we are about that in the medium and longer term. Low inflation with steady growth that is what we are on about. An inflation target is not an end to itself, but very much a means to an end."