Gordon Brown's rate dilemma

Exporters want weaker pound
A group of leading British exporters plan to lobby the new Labour government to act quickly to quell the strength of sterling.

The group, which is thought to have the backing of the CBI, will try to persuade Gordon Brown, the incoming Chancellor, not to raise interest rates early in his tenure to dampen a consumer boom in the economy. Instead, the exporters want him to look at tightening fiscal policy.

The Chancellor confirmed at the weekend that he would be meeting Bank of England Governor Eddie George for the first time on Wednesday.

In recent months, a number of British companies - particularly those that export to Germany - have reported depressed results and issued profits warnings as a result of sterling's strength against the mark. The pound has gained 2.5 per cent against the mark during the election campaign and closed on Friday at DM2.80.

Chief among these companies is British Steel, which announced in March that it was accelerating its job-shedding programme to 1,000-a-year from 500-a-year. Brokers have since cut profit forecasts for the coming year to pounds 140m, and the shares have lost 15 per cent of their value.

A British Steel spokesman said that the company had no plans at the moment to lobby the Blair government on interest-rate policy but added that the company "may say something next week".

Other exporters that are suffering from sterling's strength include ICI, Vickers, SmithKline Beecham, and British Aerospace. On Friday, ICI chairman Sir Ronnie Hampel called on the new government to pay attention to this "pressing problem". He said: "The strength of sterling is posing growing problems to manufacturing industry ... This needs to be fully taken into account by the new government as it plans its policies."

City economists believe that industry is looking for Chancellor Gordon Brown to raise taxes instead of interest rates to take some heat out of both the economy and the pound.

But they add that the Chancellor will face a difficult decision. Some economists are now calling for rises in taxes rather than interest rates to restrain demand and inflation without running the risk of boosting sterling to an unsustainable level.

"I can't see how we can avoid the danger of higher inflation without tighter fiscal policy. Even if interest rates go up to 8 per cent, that may not be enough,'' said Michael Dicks, economist at Lehman Brothers.

While Labour fought an electoral campaign saying it would not raise income taxes, it could still increase revenue through indirect and corporate taxes.

"They could abolish Miras (mortgage interest relief at source), shift allowances on income taxes, freeze or cut a number of allowances,'' suggested Mr Dicks.

If Labour ignores the overvalued pound, it might eventually be forced into a politically damaging devaluation mid-term in the same way that the Wilson, Callaghan and Major governments were morally wounded in 1967, 1976 and 1992. It would be ironic if New Labour is so zealous in its pursuit of monetary rectitude that it brings the fate of its predecessors upon itself.

Other economists are more circumspect. Kit Jukes, European economist at NatWest Markets, said emerging confidence in Labour's economic policies would make the threat of large-scale interest-rate rises recede, at least for the rest of the year.