Outlook: Pound strength

IT WAS in mid-1996 that the pound started to climb, and for the last two out of these past three years, pundits have been reassuring exporters that what goes up must come down. The pain would prove short-lived, most experts said, as sterling couldn't possibly sustain these heights - once again around DM2.95 and FF10 in old money.

Well, it hasn't happened yet and, not surprisingly, some hard-pressed companies are starting to despair. Some are responding by embarking on another round of lay offs.

It is the strength of the exchange rate that gives the Monetary Policy Committee leeway to cut interest rates again, if it so votes, after today's meeting. The renewed strength of the pound makes it hard to see how next week's Inflation Report could possibly predict an inflation rate which moves above its target range over the next two years.

City opinion veers towards the belief that the MPC will leave rates unchanged today, a decision which would call forth squeals of protest from industry groups. But whatever the outcome, the pound will indeed fall eventually. This is partly because growth in Euroland will ultimately pick up. It is also because if inflation looks like undershooting its target as a result of the exchange rate, UK interest rates will buck market expectations and fall further.

Last but not least, it will happen because the likelihood remains that sterling will join the euro. When the announcement finally comes, there will be a swift decline towards the level the market sees as a comfortable entry rate for the pound. It is one of those neat twists of history that in 1992 it was delinking from Europe that brought the pound to a bearable level; this time round it may be linking up that does the trick.