The Bank of England meets this week to decide interest rates with its policy in tatters.
Its sole aim is to keep inflation down to 2% per annum. The reason behind that instruction is to uphold the purchasing power of our currency. Neglect has led to a big devaluation of the pound, meaning our purchasing power if we wish to buy goods and services from abroad has been slashed.
As overseas trade represents a susbtantial slice of our economy, this is a serious assault on our living standards. Indeed, many of the luxuries and extras are imported, leading people to feel much worse off when their prices rise on the back of a devaluation.
The Bank’s problem is there is no easy way for it to restore the value of the pound at home and abroad. Raising interest rates would be the traditional response to a sinking currency, but in these conditions that might be seen by the markets as short term, leading to a bigger decline in economic output and worse problems next year. Markets could take fright rather than buying pounds, as they would not see it as a sustainable policy.
Cutting rates in the way we need to stimulate activity could also deter people from buying sterling, for the obvious reason that it lowers the return you make from holding the currency.
Leaving things as they are, the likely decision of this week’s meeting, just delays sorting out the mess, and may not help either. It looks like dither.
So what should the Bank do? If it were serious about rebuilding confidence in our currency, and defending its value, it would send a public letter to the government demanding they take the action needed to restore confidence. If the government produce new sensible forecasts, takes action to rein in its wilder and less desirable expenditures, sorts out Northern Rock and did one or two other things to show it wanted to get on top of the financial crisis, then the Bank could cut rates.
When the US took concerted action to improve the US economy, Fed and Administration combined, the Fed was able to cut rates and the dollar rose. It is the weakness of the UK economy that is adding to the fall of the pound.