Pound sinks as MPC reveals rates thinking

THE POUND fell to its lowest level against the dollar for almost two years yesterday after it emerged that the latest interest rate cut was backed by almost all of the Bank of England's Monetary Policy Committee.

Eight of the nine MPC members voted to cut rates by a quarter point to 5 per cent on 10 June, as hawks such as Eddie George, the Bank's Governor, switched sides. The vote was much stronger than expected and was taken as a sign that more rate cuts could be on the cards.

Sterling reacted accordingly. The pound immediately lost half a cent against the dollar, dropping below the $1.58 level for the first time since September 1997, before closing at $1.5783.

Sterling's index measured against a basket of other currencies fell to 104.1 from 104.8. The euro gained sharply, rising to 65.24p from 64.90p.

Mervyn King, the Bank's deputy governor, was the only person to vote for an unchanged rate of 5.25 per cent. The minutes revealed that the decision hinged on sterling, which some members said showed no signs of the sustained depreciation that had been forecast in its May Inflation Report. "If that strength were to persist, then the likelihood of inflation falling below target would have increased," the minutes said.

"Although the statement issued last month did not mean action had to be taken immediately if sterling did not weaken as assumed, there seemed to be no advantage in waiting."

They said that unless sterling weakened in line with the May forecast, inflation would undershoot its 2.5 per cent target.

Other factors cited in favour of a cut included falls in inflation and in private sector wage settlements, and signs that consumer and business confidence was fragile and the housing market was not experiencing a boom. However, Mr King said the exchange rate was not "significantly" different from May and warned that policymakers should "look further ahead".

According to the minutes he said there was little to change the view of the May report "that the benign effects on inflation of the rise in sterling and falls in import prices would be wearing off as domestic activity recovered".

Mr King's views were supported by some analysts. Neil Parker at the Royal Bank of Scotland said the MPC was "playing Russian roulette" by relying on sterling to restrain domestic inflation. "This could end up being a huge banana skin for them."

Meanwhile, official figures published yesterday showed that exports to the EU wilted in the face of the strong pound. The deficit in trade in goods with the EU rose to pounds 812m in April, its highest level for almost nine years and contributed to a global trade deficit of pounds 2.2bn, up from pounds 1.9bn in May.

The Office for National Statistics said the trend was for a widening deficit. The trade deficit for the first quarter of the year, at pounds 6.8bn, was the widest on record. It contributed to a pounds 1.8bn current account deficit - the worst for almost four years - and the first negative outcome for a year.

News Analysis, page 20