Thursday, 23 October 2008

Sterling slump poses challenges

Sterling started falling on Tuesday night and it continued falling yesterday closing at $1.62 or 4 per cent down on the day. On Monday it was worth $1.75. In a recession, there is nothing unusual about a flight to the global reserve currency, the dollar.

However, it does pose policy dilemmas for the UK Government. Given that the pound is also low against the euro, imports will cost more and this will have an inflationary effect. This reduces the chances of inflation falling to offset the rise in unemployment in the misery index.

It is still likely that interest rates will experience another 0.5 per cent cut, but there are limits to the extent to which interest rate cuts can offset a recession as Japan found out (rates are still only 0.5 per cent there). If rates fall too much, savers - another important political constituency - will be hit hard. They may stop lending money to building societies and banks - although they are then left with the question of who to hire their money out to, given that National Savings rates have already been cut back.

No country can insulate itself from a global recession, but political reactions can differ.

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