Bank of England: Intervention in Foreign Exchange Markets

Part of the debate – in the House of Lords at 8:08 pm on 28th March 2000.

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Photo of The Earl of Northesk The Earl of Northesk Conservative 8:08 pm, 28th March 2000

My Lords, I, too, am grateful to my noble friend Lord Blackwell for giving us the opportunity to debate this important matter, not least because we strolled through some of the ground at Question Time today.

It is one of the Chancellor's proudest claims that the Government's economic policies have ended the cycle of "boom and bust". A cursory glance at the overall figures for the economy could persuade the casual observer that the claim was justified. With due apologies to the noble Lord, Lord Desai, although I hope he will draw some comfort from my conclusions, there is another side to that coin. A number of sectoral interests--notably, manufacturing and agriculture--are in dire straits, substantially (but not exclusively) because of the strength of sterling.

As Sir Brian Moffat, chairman of Corus observed,

"Manufacturing industry in the UK is fighting for its very existence and will continue to do so. It is extremely efficient but the impact of the continued strengthening of the pound on its cost base is remorselessly undercutting its competitiveness".

Equally, while conceding that it is not as simple as the phrase implies, the "north/south divide" continues to be a running sore. As Nissan has observed:

"Should the present circumstances continue unchecked, the UK's manufacturing exporters, their export markets and our domestic markets, are at grave risk".

The company then added that its position in Sunderland "is particularly vulnerable".

Even Eddie George has conceded that,

"the worry is that it"-- that is, the strong pound--

"is producing real, sustained damage in some sectors of the economy".

In effect, the claim by the Chancellor of the Exchequer that "boom and bust" has been excised is credible only when it is applied to the economy as a whole. By definition, the economy is the sum total of its parts. To this extent, it is currently the product of the countervailing forces of a booming "new economy" set against a relative bust of the "old economy". This widening divergence--in effect, a form of internal boom and bust--is attributable in very great measure to the Government's failure to address the issue of the strength of the pound.

What all of this should tell us is that, in order to be prudent, government economic policy should be geared towards rather more than that which is expressed in the Minister's statement that:

"The best contribution that the Government can make to exchange rate stability, consistent with their objective of a stable and competitive pound over the medium term, is to maintain sound public finances and low inflation".--[Official Report, 1/3/00; col. 554.]

The Minister has used this Treasury mantra on more than one occasion. No doubt he will use it again tonight, as he did earlier today. He will also, no doubt, repeat yet another of the Treasury's mantras; namely,

"we do not underestimate the difficulties, particularly for manufacturing industry, of a strong pound".--[Official Report, 1/3/00; col. 555.]

But to what extent is it a consequence of the Government's economic policies that the pound's exchange rate with the euro is continuing to be, in the words of the Governor of the Bank of England, "unsustainable"? Moreover, in so far as the Chancellor of the Exchequer may have measures of control at his disposal, can the Government legitimately claim that they are managing the situation prudently?

The thrust of my noble friend's Question is to acknowledge that these difficulties exist and to inquire whether the Government believe that exchange rate intervention would represent an appropriate mechanism with which to tackle them. On the basis of statements from the Government to date--perhaps the Minister could confirm this again tonight--the straightforward answer would be a categoric and unequivocal "No". In January, the Minister said:

"I thought that I had already sufficiently clearly rejected the option of using a policy of intervention, sterilised or unsterilised, in the exchange rate".--[Official Report, 27/1/00; col. 1665.]

Then, only last week, he added that,

"we do not fully understand what makes exchange rates tick. Attempts to deal with them by direct intervention are likely to be doomed to failure".--[Official Report, 21/3/00; col. 138.]

Increasingly, and, no doubt, arising in part from Eddie George's insistence that the MPC's ability to influence the pound,

"is not zero but is not very great either", the argument is being advanced that the way past this conundrum is to extend the remit of the MPC. But it has to be said that the relationship between interest and exchange rates, as the Minister conceded, is far from being an exact science. More than this, in evidence to the Treasury Select Committee in the previous Session, the Governor of the Bank of England was adamant that,

"we do not believe that we can target the exchange rate consistently with targeting inflation".

As the Chancellor of the Exchequer said in the same forum,

"anybody who thinks that either dropping the inflation target to replace it by an exchange target or running inflation and exchange rate targets at the same time is the right way to achieve domestic stability or convergence is failing to learn the lessons of the 1980s".

All good and well.

Sentiment is in favour of a policy of benign neglect of exchange rates. For our part, we on these Benches support that and acknowledge the part that a strong pound plays in sustaining the overall strength of the economy. As far as concerns any central intervention, all recent evidence, not least the break-up of the ERM in 1993 or the Bank of Japan's attempts to weaken the yen last year, endorse that view.

However, this is not to say that the Government's hands are entirely hog-tied. There are a number of measures in the fiscal jam jar, not least appropriate co-ordination of fiscal and monetary policy, which, when deployed with foresight, can have the effect of producing a better balance between the "new" and "old" economies and, indeed, of rationalising the north/south divide. This really would be "prudence with a purpose". As Geoffrey Dicks at Greenwich NatWest observed yesterday in his evidence on last week's Budget:

"Fiscal policy has started working against monetary policy rather than with it".

There is a wider context to this debate to which my noble friend Lord Blackwell alluded. There are those who suspect that the Government might be tempted, at some unseen point on the horizon, to use intervention as a mechanism to deliver artificial currency convergence and thereby shoe-horn the UK into the euro. In this context, Eddie George's comments on the matter leave no room for doubt. He said:

"I have made it crystal clear that if the Government wished us to lower the exchange rate for entry into Euro purposes, it would have to change our marching orders. We would not accept a situation where we were mandated by law to move in one direction and asked to move in another".

I trust that the Minister will confirm that this is wholly consistent with the Government's position. Having said that, I cannot resist making the point that, as observed by my noble friend Lady Hogg in the Financial Mail recently:

"Somewhat contradictorily, Ministers extol the virtues of a single currency while washing their hands of the pound's rise".

Until recently, sterling's strength was having a beneficial effect on Britain's economy in terms of containing inflation and, indeed, in terms of restructuring. However, current evidence--such as the fact that, for the first time in 20 years, hourly labour costs are now higher in Britain than in France--suggests that that period has now passed. To my mind, Anatole Kaletsky summarised the position well by saying that,

"in the absence of further remarkable productivity improvements, the strengthening of the pound may now be reaching the point at which it could do the British economy serious--and lasting--economic damage and trigger a balance of payments crisis".

In our view, noble Lords on all sides of the House quite rightly agree that intervention does not provide the solution to such problems. But the simple question remains: how, therefore, do the Government intend to address these problems?