The international environment

• Growth of the world economy remains modest at around 1½% a year. The US economy has continued to expand, but relatively slowly. In Japan, growth has slipped back further. The slowdown in Germany, and tight monetary policies, have contributed to generally slower growth in Europe.
• Inflation among the major six economies was essentially unchanged in the third quarter at 3%-3½%; inflationary pressures remain subdued in most countries.
• Monetary policies are still divergent. In the United States and Japan, monetary policy was loosened further during the third quarter. In Germany, monetary policy remains tight despite the 25 basis point cut in the Lombard rate in September.
• Continued high German interest rates, together with speculation regarding the prospects for EMU in the run-up to the French referendum on the Maastricht treaty, led to unprecedented strains in the ERM in September. The lira was devalued and then suspended, at the same time as sterling, from the mechanism. The peseta was also devalued and exchange controls were temporarily introduced.
• The differential between US and German short-term interest rates widened over the summer months. This, and expectations of a further widening, caused the deutschmark to strengthen further against the dollar. The interest differential has since narrowed, however, and the dollar strengthened in October. The yen strengthened with the Japanese Government's policy announcements in August and with the increased uncertainty surrounding ERM currencies.
• Japan responded to the continued slowdown in its growth with the announcement of a ¥10.7 trillion fiscal package. Italy and Spain have restrictive budgets in the face of slowing economies.

The international environment