Monetary policy was conducted against a background of considerable economic and political uncertainty. It became apparent that output had fallen again in the fourth quarter, disappointing hopes of recovery raised by the more encouraging indicators in the late summer. More timely but partial evidence suggested that output had continued to fall in the first quarter. Monetary data confirmed that businesses had continued to adjust to weaker demand, again repaying outstanding debt to banks, as well as reducing their recourse to capital markets. And although consumer retrenchment appeared to have halted, signs of increased spending were tentative at best. The personal sector remained highly indebted, with its net debt to banks and building societies almost as great as ever in relation to disposable income. This, along with uncertain employment prospects, deterred expenditure. Uncertainty before the general election over future disposable income and capital allowances may have further deterred spending decisions by consumers and businesses. But that obstacle to expenditure has now been removed.
Rising unemployment and weak demand continued to constrain wage and cost pressures but headline measures of inflation generally showed little further decline during the quarter. Further progress was needed, particularly in non-traded sectors, before UK inflation could converge on the best performance of our ERM partners.
Market uncertainty centred on the Budget and the general election. Changing views over the likely course of fiscal and monetary policy precipitated sharp movements in gilt-edged and money markets as well as in the equity market. By contrast, sterling was relatively stable, gaining support close to its lower wide band limit. It had weakened within the ERM after the rise in interest rates in all other ERM countries in December and, because of domestic uncertainties, failed to benefit as it might have done during the quarter from the dollar's appreciation and the deutschmark's general weakening. With sterling close to its lower limit, a further reduction of UK interest rates, even if justified by the prolongation of the recession, would have risked sterling's position in the ERM and might have had to be reversed at short notice.
The money market focussed again on the possibility of a further cut in official interest rates shortly after the New Year and for much of the quarter thereafter. Expectations of a cut had first been raised in September after the reduction of base lending rates to 10½% but had fallen back after sterling's weakening in November and the interest rate rises in other ERM countries in December.
Published on
01 June 1992
Operation of monetary policy