With the Government poised to call a general election within weeks, it will hardly welcome yesterday's increase in interest rates. The scale of the increase which will be faced by borrowers may be modest probably just one half of one per cent but it may still have a strong psychological impact on consumers. There is also an impression that the Government, no less than most market analysts, was caught off guard by the increase; although wholesale interest rates had risen on the money markets in recent days, an early increase in retail rates was thought unlikely.
The success of the Government's economic policy has been largely based on its ability to maintain a low interest, low inflation environment. Invariably, the latest increase will lead to fears that interest rate levels have bottomed out and are now on the rise. But there is little objective evidence to justify any such fears.
In its own way, the current pressure on the pound which is responsible for the upward pressure on rates is a testament to the strength of the Irish economy. Investors believe that the pound is very well placed to join the single currency and are simply betting that it will go in at a lower value than its current one. And if EMU remains on course, then interest rates are likely to fall again before we enter in January 1999.
Fianna Fail and the Progressive Democrats have not been slow to blame the Minister for Finance, Mr Quinn, for the latest increase. Certainly, it would appear that the latest wave of speculative pressure is not entirely unrelated to Mr Quinn's recent comments to Reuters that he would prefer to see the pound trading closer to its central rate in the ERM. The Minister has subsequently insisted that there has been no change in policy, but the suspicion had taken hold in the markets that the Government wanted to see a weaker pound to ease the path to monetary union. Such a goal would be understandable; the Government is clearly concerned that the pound could be locked in at a high rate, which would present major difficulties for exporters. But as the then Finance Minister, Mr Ahern, learnt to his cost during the currency crisis in 1993 loose talk about the value of our currency can have unintended consequences.
That said, the political controversy is no more than a sideshow. The real significance of the increase in interest rates is that it underlines the difficulty of managing the move to monetary union. The central cause of this problem is that the Irish economy is growing much faster than the economies of the other countries with which we intend to join. Interest rates in continental Europe reflect sluggish economic conditions, while the economy here is booming.
The latest events show that the transition to monetary union may not be a smooth one. The Government and the Central Bank have some serious thinking to do on the direction of currency and interest rate policy in the months ahead.