UK rate cut puts pressure on sterling

PUBLISHED : Sunday, 13 February, 1994, 12:00am
UPDATED : Sunday, 13 February, 1994, 12:00am

THE Bank of England, in a move apparently aimed at softening the pain of imminent tax increases while sustaining economic recovery, cut its minimum lending rate 25 basis points to 5.25 per cent.

Better than expected inflation figures were cited as prompting the reduction, although sceptics thought it had more politically motivated reasons.

The cut undermined sterling causing it to break out of its recent trading range against the dollar.

Market perception that the interest rate differential between the US and Britain might narrow further in the first half of the year could cause sterling to soften to 1.44 US dollars.

Sterling also slipped against the deutschmark, retracing all of this year's gains against the German currency.

Sterling should consolidate around current levels in the near term with strong support seen at about 2.55 marks.

The cut in Britain's base rate diverted market attention away from poor German jobless figures.

Unemployment in Germany now stands at a post-Second World War high of more than four million people.

The news comes at a bad time for the German Government. In one month's time the first of the state and local elections are to be held, marking the start of the run-up to the federal election in October.

Although the Bundesbank is an independent body, there will be growing pressure from political circles for a cut in interest rates ahead of the elections.

The inevitability of lower German rates suggests that sterling is likely to head back towards 2.60 marks in the medium term.

The Bank of Canada raised its key lending rate, the first rise in seven weeks, to help stop the Canadian dollar's slide.

However, with the date of the 1994 budget soon to be announced, the Canadian dollar is likely to be more influenced by sentiment towards the budget than technical factors.

James Mitchell is an economist at BNP International Financial Services (HK)