Operation of monetary policy

Quarterly Bulletin 1991 Q2
Published on 01 June 1991

This article covers the period from January to March.

The successive ½ percentage point cuts in interest rates over the first quarter reduced the general level of rates to 12½% by end-March, and to 12% by early April. This easing of monetary conditions was made in the light of developments in the domestic monetary and economic situation and taking full account of the need to maintain market confidence in the authorities' commitment to the counterinflationary stance of policy and to the ERM discipline. The markets' response to the cuts, when they came, suggested that they had indeed been accepted as prudent.

Monetary conditions also eased over the quarter as the exchange rate depreciated in effective terms. Much of this reflected the depreciation of sterling against the strengthening dollar from mid-February onwards. The combination of dollar revival and deutschemark weakening was, however, particularly favourable to the position of sterling within the ERM, so that sterling moved from being the weakest member currency in early January to second position by end-March, before falling back more recently.

On the real economy, data which became available during the first quarter confirmed that the economy had moved rapidly into recession in the second half of 1990 and that output and demand continued falling into 1991. Hard evidence of a downturn in underlying inflation, particularly in wage settlements, remained disappointingly modest, although the demand-side pressures responsible for the original upsurge in inflation had clearly abated. Hopes of a revival in business and consumer confidence appeared to emerge during the quarter, in part associated with the ending of Gulf hostilities, leading some markets (most notably equity markets) to strengthen on the expectation of earlier economic recovery.

The authorities judged that the developing economic and monetary situation fully justified a lowering of interest rates from the 14% level established at the time of ERM entry last October. The process was deliberately cautious, in order to ensure the maintenance of confidence in the authorities' anti-inflationary resolve, to allow a considered assessment of economic developments and to discourage over-optimistic market expectations of the speed of further rate cuts.

PDFOperation of monetary policy


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