Operation of monetary policy

This article covers the period from July to early October.

The economic and financial indicators released over the third quarter provided unambiguous evidence that the sustained period of tight monetary conditions has slowed activity in the real economy, with the signs becoming progressively clearer and more widespread. As expected, however, adjustment in the real economy has preceded adjustment in inflation.

The tight policy stance, with interest rates maintained at 15% throughout the third quarter, was reinforced by the appreciation of sterling, which was attributable in part to anticipation of ERM entry and, in the immediate aftermath of the Iraqi invasion of Kuwait, to a degree of petro-currency support. Expectations about the timing of ERM entry were an important factor in explaining movements in most UK financial markets over the period. Entry took place in early October when, as discussed in the Assessment, the combination of the slow down in economic activity and the projected easing of inflation provided an appropriate conjuncture for the United Kingdom to join, with a simultaneous reduction in the general level of interest rates to 14%.

The stance of monetary policy has not been significantly altered by entry into the ERM: the continuing restraint exercised by interest rates at 14% has been reinforced by the contribution to counterinflationary policy stemming from ERM obligations. In the present circumstances, the authorities have continued to indicate that interest rates will not be reduced further until they are sure that it would be safe and prudent to do so.

Operation of monetary policy