Rule Of Thumb, Rule Of Pound

19th August 09 – Rule of thumb, rule of pound

Two days ago, entry for 17th August, the stated reason for the extra £50bn of QE money printing was due to the banks still not lending to businesses (dealt with in detail tomorrow). But some informed commentators are muting, or muttering, that this was not the real reason for the great pump-priming or at any rate was certainly not the sole reason. It is to do with rule of thumb. The pound has appreciated against the greenback by 6% in the past quarter and by the famous rule of thumb, this is reckoned to be equivalent to an interest rate rise of 1.5 interest rate points. Given the current base rate of 0.5%, this means a quadrupling of the true cost of money on the exchanges.

The point is that the B of E does not, as an issue of policy, aim at currency rates. This is, for example, in contrast to (say) the Swiss National Bank. But if the rule of thumb about the relationship between the strength of a currency and domestic base rates is about right, then to issue money knowing it will reverse a currency appreciation, amounts to the same thing as intervening in the currency market. Except it is a bit more subtle.

Hans Redeker of BNP Paribas is quoted as saying “Unless the UK is ready to deflate its production costs heavily, it can only achieve required competitiveness by reducing the value of sterling… The BofE knows this and its decision to increase its quantitative easing efforts may well have to be seen in the context of summer sterling strength.”

So there we have it. Rule of thumb to rule the pound, but indirectly. Not that there is as yet much evidence that exports are responding to a relatively weak pound. Part of the reason for this can be found in tomorrow’s diary entry.

More comment at http://www.jgwalkersmith.co.uk