Exchange Rate Mechanism

Part of the debate – in the House of Commons at 3:38 pm on 15th October 1990.

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Photo of Mr John Major Mr John Major , Huntingdon 3:38 pm, 15th October 1990

I should like to make a statement about sterling's entry to the exchange rate mechanism of the European monetary system, which took effect on Monday, 8 October.

Sterling now has a fixed central rate against each of the other currencies in the ERM. The entry rate is set against the ecu and translates to a central rate against the deutschmark of DM 2·95. That was marginally above the market level when the decision to enter was announced on Friday, 5 October and is a little below the current market rate.

Sterling is able to move by a maximum of 6 per cent. above or below the central rates. Our choice of the wider 6 per cent. margins is intended to allow sterling to settle into the system, and follows recent precedent. In due course, we will move to the narrow band of 2¼ per cent. margins. The terms of entry we have agreed with our partners are those that we sought.

The Government have long made it clear that sterling would enter the exchange rate mechanism during stage 1 of economic and monetary union, which began in July. It has now done do, at the earliest appropriate time. I would like to explain how our decision fits into the Government's wider economic strategy.

It has become abundantly clear that policy is now reducing inflationary pressures in the economy. Monetary growth on all measures has fallen sharply, and the growth of narrow money is within its target range. The growth of demand has slowed. Although the rise in oil prices will continue to feed through for a while, the prospect is for a substantial reduction in inflation over the coming year. That will be so both in absolute terms and in relation to inflation in other European countries. It was for those reasons that we felt able to reduce interest rates by 1 per cent.

A firm exchange rate is a vital part of our policy to maintain tight monetary conditions in order to reduce inflation. As I have repeatedly made clear, membership of the exchange rate machanism will be an additional discipline for the United Kingdom economy. In no sense is it a soft option. Monetary policy will remain tight. I must emphasise that I will not make a further reduction in interest rates until I am sure that it is safe and prudent to do so.

Membership has important implications for British companies and their employees. They must contain their costs. If they fail to do so, they will not be bailed out by a devaluation of the currency. That is the key message for those engaged in pay bargaining this autumn and subsequently.

But in addition to acting as a discipline on costs, membership of the exchange rate mechanism offers significant benefits for British industry. It will help to provide greater stability of exchange rates with our main trading partners and thus the certainty that business needs to plan for the future. It will also make Britain even more attractive for inward investment.

Although entry to the narrow band of the exchange rate mechanism will fulfil our obligations under stage 1 of economic and monetary union, it does not imply any change in our opposition to the imposition of a single currency. In the intergovernmental conference in December, we shall continue to argue against that plan and for the proposals that I first set out in June. As the House knows, they propose an evolutionary and market-based approach, based on the creation of a new European monetary fund and a common currency—the hard ecu.

In summary, the mechanism has a proven record of success over recent years in producing greater stability of exchange rates and lower inflation. The Government believe that Britain too will benefit from membership. The exchange rate mechanism will reinforce our counterinflationary policies, help to provide the stability and certainty that industry needs, and set the right framework for a resumption of soundlybased and non-inflationary growth. I commend entry to the House.