The Government may have thought it had until May to decide the rate at which to tie the pound into EU monetary union. In fact, the time has now arrived. If the Minister for Finance wants the Irish currency to lock in above its current ERM central rate of DM2.41, then he will have clearly to indicate this very soon. Otherwise the markets will drive the currency down to the DM2.41 level, making it very difficult to enter at a higher level.
Whether Mr McCreevy will be more forthcoming is not clear, although he is likely to hold his counsel for the moment. If he remains silent, then the financial markets will take the view that he wants the pound to lock in to monetary union at DM2.41 and further assaults will be made on the currency until it reaches this level. If the Minister wants a higher entry level for the currency, then he must indicate this to the markets quickly. Some market sources believe that, if there is no official comment over this weekend, then the pound will face a further wave of selling next week. The selling of the Irish currency in recent weeks has not been on a massive scale. But it has been consistent. Day after day what interest there has been in trading in the Irish currency has been in selling it. There have been few buyers in the market, although some have emerged over the past couple of days as some institutions appear to have taken their profits. This profit taking, together with some weakness of sterling yesterday, led to some easing of the pressure on the Irish currency. And the traditional market caution on Fridays about the possibility of official weekend announcements when the market is closed may mean that trading is also quiet today. But if the weekend passes without any sign from the Government that it is unhappy about the currency's decline, then the pound will remain under pressure next week.
We do not know, of course, what view Mr McCreevy and his colleagues are taking on the subject. Market analysts conclude that they are happy to see the pound enter monetary union at its DM2.41 central rate. They point out that all the organised lobby groups such as the exporters and the farmers favour this approach, and that there is little political mileage in opting to join the single currency at a higher rate.
However, Mr McCreevy's own officials and the Central Bank are likely to be giving him other advice. The Central Bank, in particular, signalled in its monetary policy statement that it was concerned about the outlook for inflation. Already the economy is booming, there was an expansionary Budget and house prices are soaring.
The Bank will argue that the last thing the economy needs on top of all this is a fall in the value of the currency. Its trade-weighted index its average value against the currencies of our trading partners is now 6 to 7 per cent below last year's average. The danger is that this will soon start to feed through into higher import prices.
Importers who may have bought sterling forward will soon run out of cover meaning the higher prices will be passed on to consumers. And analysts point out that with the pound now falling against most major currencies, companies will not have the option to switch from a supplier in a country against which the pound is weak to one against which it is stronger.
The danger which a pick-up in inflation over the next year would pose are clear. It would put pressure on Programme 2000, at a time when trade unions are complaining that the Budget benefited the better off. And it would threaten Irish competitiveness as we are heading into monetary union.
The Central Bank would be powerless to act, as it has conceded in its annual monetary policy statement this week that interest rates are set to fall sharply in the run up to monetary union. In normal times, the bank would already have pushed up interest rates significantly in a bid to cool the housing market. But now it must sit back and see interest rates fall further, adding further fuel to the economy's fire. So what should the Minister do? He is not short of advice. The argument has concerned whether the pound's central ERM rate should be revalued to allow us to enter monetary union at above its DM2.41 central rate. Those in favour of revaluation argue that allowing the currency to fall further in the run-up to monetary union would fuel inflation.
Proponents of joining at the DM2.41 rate argue that entering at the lowest possible rate would go some way towards safeguarding competitiveness once inside EMU and protecting Irish industry if sterling were to fall sharply. And with no information forthcoming from the Minister, the market is taking the view that Mr McCreevy will opt not to revalue, partly in the hope that sterling will ease back over the next year, offsetting to some extent the inflationary risks posed by a DM2.41 entry rate. However, any easing in the sterling exchange rate in the months ahead may come too late to offset an expected rise in the rate of inflation. Economists cannot now agree on how serious is this threat of a pick-up in the rate of inflation. The economy has broken all the rules in recent years, growing at a record rate while still maintaining an exceptionally low rate of inflation. Precisely what forces are behind the low rate of inflation are not clear.
However, such is the strength of the economy and the stimulation it will receive from the Budget, falling interest rates and the declining pound that there is a risk of significant pressure on prices in the months ahead. If Mr McCreevy does not put some of his cards on the table, the financial markets will make the decision for him.
