Treasury stands by exchange rate discipline

A TREASURY minister delivered a blunt warning yesterday that Britain would not compromise its monetary policy, amid continued City speculation that a further cut in interest rates could be on the way.

Stephen Dorrell, Financial Secretary to the Treasury, mounted a tough defence of Britain's membership of the European exchange rate mechanism in terms which will be taken as a warning to backbenchers tempted to blame ERM for the delayed economic recovery.

Mr Dorrell gave no hint on short-term base rates. But in a wide-ranging speech defining post-Thatcherite economic policy he warned that the Government would resist 'the clarion call of the easy cop-out'.

He added: 'We are determined to match our standards of monetary discipline to the best in Europe, because if we don't we shall continue indefinitely to impose a needless handicap on the process of wealth creation.'

Mr Dorrell, who is on the left of the Conservative party, in effect turned the tables on right- wing critics of the Government's economic policy by making clear that the defeat of inflation was the highest priority and that ERM was the best method of monetary discipline.

He said: 'More words have been spoken about the need to maintain the value of money than about any other subject in economics. And yet only since we joined the ERM have we had the courage to commit ourselves irrevocably to turning fine words into real deeds.'

Mr Dorrell's speech - intended to define overall strategy rather than short-term policy - came amid City speculation that the Bank of England is clearing the way for a further cut in base rates timed to coincide with this week's World Economics Summit.

Despite strenuous denials by senior Whitehall officials that any such preparations were underway, there is a growing conviction in the City that the authorities will act, if they can do so without endangering the pound's stability inside ERM.

Leaders of the Group of Seven rich industrial states, who begin a three-day meeting in Munich tomorrow, are increasingly worried that the fragile economic recovery may fail to hold. In Britain, Treasury officials openly acknowledge there are few, if any, signs of an upturn.

The leaders are expected to make clear that it is only a matter of time before further reductions in European interest rates - including those in Britain - can be made. But officials emphasise that no immediate action can be expected at the summit.

At 10 per cent, Britain's base rates are only a quarter point above Germany's key Lombard rate - the ERM benchmark below which other EC rates can rarely fall without risking weaker currencies.

But the City believes the Bank is exploring whether the markets will tolerate a small cut in UK rates ahead of a fall in German rates later this year.

The Prime Minister re-affirmed his hope yesterday that the multi- billion-pound European Fighter Aircraft project would go ahead, and repeated that Britain had still not received official notification from the German government that it intended to pull out.

Mr Major said: 'We believe it is certainly possible to reduce costs of the European Fighter Aircraft and we equally take the view that the alternatives to EFA are likely to be more expensive, not less expensive, and will take longer to produce.

'We still see EFA as an important project. We must wait and discuss the matter further with our partners, but we hope it will be possible to continue with it.'

At crucial talks tomorrow with Volker Ruhe, the German Defence Minister, Malcolm Rifkind, the Secretary of State for Defence, will seek to clarify Germany's exact position. He will also press Mr Ruhe on whether Germany is considering opting for the French Rafale aircraft instead of going ahead with EFA.

Mr Ruhe is expected to meet members of the Tory backbench defence committee later.