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Dear Mr King
Before we set out the views of the Labour Economic Policy Group for this month`s Monetary Policy Committee meeting, can we first of all offer our congratulations on your accession to the Governorship of the Bank and Chair of the Committee.
You have a difficult act to follow in Sir Edward. He`s been a wise and canny Governor. We commend the example he has set in holding a balancing role on the Committee, rather than automatically espousing, or imposing the views of the Bank which, in our view, always tend to excessive caution. The MPC exists to widen the scope of advice and opinion and to articulate the interests of other sectors of the economy, particularly the non-finance side. It would undermine the whole purpose of the MPC if its decisions became a matter of Bankers versus the People. The two sides should not be polarised but participating in a debate. If the Bankers always win the MPC fades.
In previous months we have urged the Committee to reduce the short term interest rate substantially. We do so again. The long delay in reduction makes the matter more urgent and the necessary reduction more substantial. This month we want to put a figure on the necessary reduction of two percent. That figure is deliberately chosen to bring British rates slightly below those in Euroland and slightly ahead of those in the United States. The Fed and the ECB have both opted for low interest rates as a stimulus to their economies as well as a boost to the world economy. We should play our share in both processes. The British economy needs boosting in the same way. It would send entirely the wrong signals if the world`s fourth or fifth biggest economy stood aside from these benign processes, as we currently are doing to the damage of our economy and the world`s.
The world is entering a period of currency adjustment after the dollar (and the pound) have been too high for too long, leading to substantial trade deficits for the US and, on a smaller scale, us. That has created a situation in which markets are going to bring the two exchange rates down. The Americans are viewing that process with benign neglect because of the economic stimulus it gives, particularly to US manufacturing,
but British reactions seem more doubt-filled and old fashioned. The euro has been rising from the depths it plumbed since launch. It would and should go higher were it not such an imperfect currency run on an incomprehensible basis. Those flaws don`t create confidence. In this situation the pound is still substantially overvalued, in our view by as much as a third. It needs to come down with the dollar, indeed probably more than the dollar. Yet it isn`t doing so. It also needs to come down against the euro. Both these processes should be encouraged.
These adjustments should be allowed to happen naturally and on similar terms to the dollar and the euro. It would be perverse and damaging to the real economy, and to production in this country, if we attempted to shore up sterling by rates currently nearly double Europe`s and over three times US rates so as to hold ourselves aloof and keep our rates higher here than elsewhere. You can`t buck the market. Any attempt to do so is doomed to failure. It will produce damaging consequences and an undershoot later on, where acting now and giving the correct signals allows the adjustment to be both gradual and natural.
A look at current economic trends indicates not only the possibility of a substantial interest rate reduction, but the need for it. Inflation is no real problem. Current levels permit an interest rate reduction in anticipation of further falls to come (reversing the usual process of an MPC which has been all too prone to raise interest rates in anticipation of inflation rises it sees (usually wrongly) ahead). Inflation is no longer a problem. Indeed, there is a growing concern about deflation. British levels are well in line with American and European and would permit a greater reduction in interest rates than Europe or the Americans have opted for.
The economy is still slowing. It is running at levels well below Treasury forecasts and needs the boost of lower interest rates and the more competitive exchange rate they will bring. An economy heavily burdened with debt must veer to contraction and certainly can`t grow unless the debt burden is eased by lower rates, which are now the only means of sustaining present low growth levels, let alone boosting them. Consumer demand is much weaker and can only be revived by lower interest rates.
Like demand house prices are visibly slowing. The Bank has been excessively influenced by them in the past but we can now envisage a situation where a slight boost to further price rises is a necessary stimulus to the economy. Certainly they can`t be used as a justification for keeping interest rates at the present excessively high level.
Finally, we would repeat the point we have made in previous months. There is no reason to use high rates to counter any future fall in sterling on the grounds that devaluation would be inflationary. It would not. There is no precedent or higher inflation arising from previous devaluations. Most notably that after we left the ERM which had no inflationary consequences. It is clear that in a world which is far more intensively competitive than it has ever been, competition itself will inhibit price rises. Importers will hold prices to keep market share. Raw material import prices will be held for the same reason and because demand for them is currently so slack.
In the long run, only a competitive exchange rate can stimulate and sustain expansion in this country because only that can bring under or unemployed resources back into production, bring down unit costs, make it profitable to produce here (which it still isn`t for too much of manufacturing), halt the decline, give our flagging export sector a prospect, and boost the benefits of adding value here rather than importing finished products or components and exporting jobs. When we are even expanding call centres and their jobs something is drastically wrong.
Thanks to what appears to us to have been a deliberate Bank policy of keeping the pound high by interest rates higher than necessary, to control inflation by disciplining production and subsidising imports, the economy has been run down. We now export jobs and import finished products and, where possible, components to the great damage of manufacturing which remains still basic to world trade or exports and British employment.
We look forward to an outcome from the MPC`s meeting which, if it doesn`t reduce interest rates as its outcome, will be viewed as a futile abdication. Once again, however, we emphasise that that reduction needs to be more substantial than the fiddling, pathetic ¼ % shifts the MPC has preferred in the past. The time for caution is over. The decline is too far gone to be ignored. The real economy has declined further than either the Chancellor or the Bank envisaged. The long overdue reduction in interest rates, therefore, needs to be more substantial at 2% than those envisaged up to this point and we can`t be left with British rates sticking out like a sore thumb in a world of ever cheaper money. Wake up to the real world!
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