Operation of monetary policy

This article covers the three months from October to December 1988.

Following the series of interest rate increases between June and August, monetary conditions were tightened further late in November, when the emerging indicators showed domestic demand stronger than had been expected when interest rates had last been raised. Since November there have been indications of a slowdown in domestic demand, though they are still not conclusive.

There were signs in the early autumn that mortgage lending had begun to slow down and retail sales to flatten out. However, these tentative indications of moderation in domestic demand were not corroborated by any other evidence; and the indicators for October-a sharp increase in retail sales, continuing inflationary pressures and a record current account deficit-showed that domestic demand was stronger than had been expected. In response, interest rates were increased by one percentage point on 25 November, with banks' base rates rising to 13%. Market sentiment had shifted towards the end of October to an expectation that interest rates might need to rise from 12% at some stage, but the indicators which were published in November and the move to 13% immediately after the announcement of the October current account deficit surprised the markets. Market nervousness in the aftermath of the increase in interest rates soon gave way to optimism that the next move would be downwards, albeit not until well into 1989, and this was reflected in the level and slope of the money-market yield curve in the second half of December. Sterling was generally firm during the period and ended the quarter 2. 5% up in effective terms.

Operation of monetary policy