The currency markets are again causing problems for the Government and the Central Bank. Sterling is rising strongly and this is causing two unwelcome trends in the pound's exchange rate. First, the Irish currency is falling against sterling, dipping below 95p sterling yesterday for the first time in over three years. And second, the pound is being pulled up against the other ERM currencies, such as the deutschmark and the French franc.
The pound's fall against sterling will certainly be welcomed by exporters to the UK market. However, the Government and the Central Bank may be concerned that a sustained fall in the value of the pound against the currency of our major trading partner could fuel inflation by pushing up import prices. Fortunately, the latest inflation figures for March show little sign of any emerging price pressures.
The rise in the pound's value against the other ERM currencies is also unwelcome from the point of view of the Government and the Central Bank. In less than two years time, the Government wants the pound to join the EU single currency along with most of the other ERM currencies. But it would not like the pound to join at its current high exchange rate against currencies such as the deutschmark and the French franc. The transition to the single currency would be much easier to manage if the pound were to fall closer to its central rate in the ERM.
Unfortunately, there is very little that the Government or the Central Bank can do to influence the pound's value. Central Bank interventions in the markets can sometimes influence the pound's value. And it seems that, for the moment at least, the Bank is prepared to allow the pound to fall in value against sterling, rather than rise too much further in the ERM band. A decline in the value of sterling would solve many of the problems facing the authorities. They will hope that the recent strength of the British currency will prove shortlived and that it may decline again in the run up to the Westminster election, or when the markets start to focus on the problems facing the incoming government.
Sterling has certainly had an extraordinary run in recent months and it is quite possible that it may soon fall back in value. But experience shows that currency forecasting is a complex and difficult exercise. For the moment, the Government and the Central Bank can only hope that the turning point in the British currency's fortunes comes sooner rather than later.
It might be tempting to conclude that the problems of currency management will disappear after the creation of the single EU currency. And to an extent they will. But with sterling almost certain to be outside the single currency zone, at least initially, and the pound likely to be among the founder members, Irish policy makers need to decide on how they will respond to sterling volatility after monetary union. The onus must be on creating flexibility in other areas of economic management so that Irish policy can respond to sterling swings, or other economic challenges, once we are inside the single currency. This issue needs urgent attention from policymakers, as highlighted in a recent report from the National Economic and Social Council.