Sterling & Inflation- (21.01.02)

The Ernst & Young ITEM club, a group of industrialists and economic modellers have suggested that the value of Sterling should be depreciated by 10% against the Euro to help manufacturing industry compete. This has been justified using Treasury's economic model to calculate that this would still leave inflation under the 2.5% target.

I can agree that inflation would remain under 2.5%, but it is difficult to see what a government could do to achieve this deflation. The suggestion made by ITEM that they could sell Sterling would be like pouring money down the drain. Just as Argentina can't buy their currency forever in support of a fixed exchange rate, so the reverse is true. A government that tries to deflate the exchange rate will see this corrected to the true market rate as soon as the support stops, to a short term benefit at best, along with the corresponding imported inflation. Surely manufacturing industry is better off with a STABLE exchange rate rather than a short term fluctuation downwards (along with stable prices, sustainable economic growth and low interest rates). Foreign exchange markets operate like this to prevent manipulation of them by governments.