The Dollar could slump by another 15 per cent, creating a potential headache for the Bank of England, its chief economist warned last night.
Charlie Bean said the implications for the UK economy depended "critically" on the knock-on effect on the pound and demand for UK exports. He said so far sterling's rise against the dollar had been offset by a fall against the euro, leaving UK competitiveness intact. "But there can be no guarantee that this pattern of 'sterling-in-the-middle' will continue," he told regional business leaders in East Anglia.
Mr Bean said economic imbalances in the US meant the dollar would have to fall further to avoid a major slump. The last time the dollar fell to eliminate current account and trade deficits it crashed by 30 per cent. "To date it has only fallen 15 per cent since its peak so a further - possibly substantial - decline may accompany closure of the current account deficit," he said.
"The timing and nature of this adjustment is very hard to predict and the implications for UK prospects depend critically on what then happens to demand in our major export markets and the impact on sterling."
Mr Bean's comments came as the euro surged through the $1.32 barrier to push the dollar to a record low for the fourth day in a row.
The pound inched higher versus the euro, pulling further off an 11-month low set on Monday. Were the pound to continue to rise against the euro that would deliver a double blow to exporters and put pressure on the Bank to cut interest rates, economists believe. On the other hand economists warn the UK's housing bubble and trade deficit could trigger a similar fall in sterling, that could drive up inflation. HSBC is forecasting a 10 per cent drop in the pound/euro rate by 2006.
Mr Bean also reiterated the Bank's concern that house prices may fall more severely than they expect and trigger a larger decline in consumer spending - which would also open the way to a rate cut.
He echoed the warning in this month's Inflation report that the low levels of inflation on the high street and in the labour market might reverse, possibly prompting the need for a rate rise.
Meanwhile the CBI warned that Gordon Brown would have to raise taxes or cut spending in a third Labour term, as it slashed its forecasts for growth and tax revenues next year. The country's largest employers' organisation said rises in interest rates and oil prices and the slowdown in global growth would put the brakes on growth in the UK.
It cut its forecasts for this year and 2005 by 0.3 of a percentage point to 3.1 and 2.5 per cent respectively and for the first time pencilled in growth of 2.6 per cent in 2006. It is the second time in three months the CBI has cut its forecasts.Reuse content