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Sterling, economic growth and interest rates

One immediate effect of the 0.8% rise in UK economic growth during the third quarter, which was announced yesterday, was an upward valuation in sterling.

The pound rose by about 1.5 cents against the dollar and stands at $1.5814 this morning, according to Reuters. The pound has now risen by almost 2 cents this week. The story is the same against the euro, with the pound reaching 1.1452 euros today,- a rise of about 1.7% this week.

The pound has risen against other major currencies following impressive economic growth figures.

What are the implications of this increase in the value of the pound? Initially it will make our exports more expensive and our imports cheaper. If this situation is maintained, it will have the positive effect, other things being equal, of reducing the levels of imported inflation. However, on the other side of the coin, it will make it more difficult for our exporters to sell abroad, particularly into our main euro area and US markets.

Also, the positive growth figure allied with the hitherto stubborn levels of UK inflation, will have implications for the Bank of England’s Monetary Policy Committee (MPC). Yesterday, Andrew Sentence, a member of the MPC, was quoted as saying that he was in favour of lifting interest rates. But, such a rise is likely to boost the value of the pound even further.

Mr Sentence said: “There is a bit of a mismatch between what’s happening with inflation and growth …. and the level of interest rates. I am in favour of gradually moving interest rates up from their very low level which I think can be done without disrupting business or consumer confidence.”

Will interest rates go up? There is only one direction they can move in since they have been at 0.5% since March 2009, and some traders are predicting a rise up to 1.0% by the end of next year. But will they move sooner rather than later? Although the only MPC target is to control the level of inflation, would they fail to take into account the fragility of possible future growth?

A rise in rates is likely to dampen both consumer spending and business sentiment. What is certain at the moment is that the MPC will put the ‘quantitative easing’ option back in the drawer for the time being at least.

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Posted in Bank of England, economic growth, Exchange Rates, Inflation, Monetary Policy Committee, sterling

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