View from City Road: Never mind base rates, the pound is the problem

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The Independent Online
There are two convincing scenarios for an immediate drop in UK base rates: a larger cut in German interest rates today than the half point that has been widely discounted, or a grudging one that fails to satisfy the foreign exchange markets.

In both cases, the British government will need to play it by ear since the key to any decision should be the movement of the pound in reaction to events in Europe, rather than domestic pressures on the Chancellor.

In the first scenario - say a full 1 percentage point reduction in German rates - the exchange rate mechanism might struggle on in its present form but upward pressure on the pound would become embarrassingly strong. In the second, the risk is that the ERM would be pitched back into crisis, the franc would be devalued and the pound would again be the likeliest winner.

The problem is that the rise of sterling in recent months has had the effect of tightening monetary policy significantly, while exporting has become tougher just as European markets have dived into recession.

It is the pound that the CBI should be worrying about, rather than base lending rates. Yesterday's figures showing an easing of the repossession crisis and earlier data showing that negative equity is in retreat confirm that the housing market is over the worst, and is no longer a reason for lowering rates.

It is quite possible that the pound will weaken of its own accord over the next few weeks, if the economic indicators prove as disappointing as feared. Only if that weakening does not happen should base rates be cut.