The Monetary Stimulus

There was no change to UK base interest rates this week with the Monetary Policy Committee holding rates at 5.0% for May. Across the Channel, the hyperactive (!) European Central Bank also kept policy rates constant for what now seems like an eternity! Thank heavens the UK remains outside the Euro Zone! Whilst policy rates are at 5% for the moment, this does not mean that monetary policy is not acting as a stimulus to one or more of the components of aggregate demand (C+I+G+X-M).

The overall stance of monetary policy includes the effects of base rate movements and also changes in the external value of sterling against a basket of other currencies. So whilst interest rates have edged lower in recent months we should also take into account the major depreciation of sterling against the Euro Zone with whome we do more than half of our trade. A falling pound acts as an important stimulus to the export sector of the economy, even though the boost is muted somewhat by a slowdown in economic growth in our export markets. Will the lower pound be a white knight for the faltering UK economy?

Better off out than in?

Yes says Ambrose Evans-Pritchard in his piece in the Telegraph today arguing that the UK economy might have been dealt a much tougher blow from the fallout from the credit crunch had we been locked into the single currency zone. I have been discussing this with my A2 students this morning. When external shocks occur, the key to stabilising prices, demand and output is to have a flexible supply-side, fiscal policy autonomy and control over monetary policy. The UK has all three to a reasonable degree and I cannot help thinking that the sliding sterling-euro exchange rate is key to all of this.

Ambrose writes: “As Neil Mellor from the Bank of New York Mellon points out, the pound has been perfectly hedged in this cycle. Sterling has fallen hard against the euro, giving a shot in the arm to British manufacturers (yes, they still exist, 13pc of GDP) who rely heavily on Europe’s markets: yet it remains overvalued against the dollar, softening the effect of oil, metal, and commodity inflation. The shock absorber is working. The Bank of England has already cut rates three times.”

It is interesting when you chat to city and industry economists that discussion of the possible entry of the UK into the Euro Zone is completely off the agenda, the prospect does not exist. The debate has moved on for good.

Does a current account deficit matter?

Yes according to economist Roger Bootle writing in the latest edition of the Deloitte Economic Review and reported in this article from the Financial Times.

“Britain is headed for its highest peacetime current account deficit and both household and government spending will have to slow painfully to correct it, according to economist Roger Bootle”

Cheaper sterling to the rescue?

For some time now I have been arguing that the media should be paying more attention to the exchange rate when considering the propsects for the UK economy over the coming months. A cheaper currency acts as a boost to exports and aggregate demand and can be a very useful stabiliser in an economy weakening from the fall-out from the credit crunch. There are naturally risks from a sharp downward movement in the exchange rate, not least the impact on the prices of imported products and possible flow-through effects on cost and price inflation. But taken as a whole, a lower exchange rate is what the UK economy needs at the moment - and we are getting it! Charles Bean, Chief Economist of the Bank of England made clear reference to this in an important speech in London today - it is available to download here from the Bank of England website. I have picked out one paragraph in particular which focuses on the exchange rate and compares the impact of cuts in interest rates with currency depreciations.

Chart of the Day: Imported Inflation into the UK

Our chart for the day is linked to the news that the pound has fallen to an historic low against the Euro. One of the consequences of a depreciating currency is that the prices of many of the goods and services we import from overseas goes up potentially leading to a fresh burst of cost-push inflation.

Interest rates, exchange rates and annual holidays

As expected, the Monetary Policy Committee of the Bank of England has cut the base rate by 0.25% today.

Currencies hit the Headlines

Two currency movements are in the news today. Firstly the pound has fallen to an eleven year low against the Euro with one Euro now worth eighty pence. The second currency hitting the headlines is the Chinese renminbi which has appreciated beyond Rmb7 to the US dollar for the first time since 1994.

Revision: The Pound Falls to 5 Year Low against the Euro

Today’s revision note is on exchange rates and is designed for AS students - the pound has slipped to a five year low against the Euro. It is perhaps the result of the Euro’s strength against the US dollar rather than any fundamental collapse in market sentiment against sterling.