George argues for rate increase

Eddie George, Governor of the Bank of England, yesterday took issue with the Chancellor of the Exchequer's claim that the strength of the pound was a good reason for not raising interest rates last week.

In a speech to a Institute of Bankers dinner in Scotland, he said "there could be real dangers in allowing justified concern about the exchange rate to deflect us for too long from moving gradually to moderate the upswing" in the economy.

Last Thursday, Kenneth Clarke, the Chancellor, justified his decision not to raise base rates the day after his monthly monetary meeting with Mr George by saying: "The big thing is that the pound is very strong at the moment and it is very anti-inflationary."

As the pound strengthened further yesterday against the mark, Mr George made clear that the Bank wanted a small rise in interest rates. He also emphasised the need for a gradual tightening to "moderate" the upswing rather than bring the economy to a jarring halt.

However, he reminded his audience that two years ago his message about interest rates was that a stitch in time saved nine and he added: "I bring you the same message."

The speed and size of sterling's appreciation was causing "understandable anxiety", particularly for manufacturers exposed to international competition.

This was already affecting export orders, "clearly a serious issue", creating tension between the strong exchange rate and domestic policy.

But Mr George repeated the Bank's long-standing argument that the stronger exchange rate did not directly affect the problem of the build-up of domestic demand pressure. It would have a one-off downward effect on retail price inflation, but this would drop out of the 12-month calculation during 1998.

The stronger exchange rate would also weaken the trade balance, relieving the pressure on demand, which may have a more lasting effect on inflation.

The Bank would take these factors into account, though there was inevitably a great deal of uncertainty over the timing and scale.

The index for the pound rose 0.2 to 96.8, while against the mark sterling rose 1.14 pfennigs to DM2.7004.