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Exchange rate rise proves to be the crucial factor in Bank base rate cut

  • 15/07/2003
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The pressure on the Bank of England to stimulate the economy with a cut in base rates has finally pr...

The pressure on the Bank of England to stimulate the economy with a cut in base rates has finally prevailed, with the Bank’s Monetary Policy Committee (MPC) cutting UK interest rates by a quarter of a percentage point to 3.5%.

Prior to the announcement, economists had almost unanimously thought the decision could go either way. The argument for a rate drop hung on a statement by Mervyn King, the new governor of the Bank of England, that: ‘Perhaps the most significant change in the past month has been the rise of the exchange rate and that will make some difference to the outlook for growth. This will have to be factored into our decisions.’

Commenting on this statement, Laurence Sanders, economist at Bristol & West, said: ‘There is no strong economic case for a base rate reduction. However, King’s comments on the exchange rate, suggest that the MPC might follow the example of the US Federal Reserve Board, and use an 0.25% base rate reduction as an insurance policy against a future downturn in world growth.’

A fall in the value of sterling makes importing expensive, pushing prices higher and threatening inflation targets. An increase in the value of sterling recently partly lifted this threat and made a cut possible.

Discussing the housing market viewpoint, Sanders said: ‘A decision to leave base rates on hold would have improved the prospect of a soft landing in the housing market.’ He forecast that the annual rate of house price inflation will fall to 7.1% by the fourth quarter this year, but that it will rise again next year.


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