We can, and have, and I hope will, take account of the exchange rate in our tactical approach to monetary policy. But with the best will in the world, what we cannot sensibly do, is to ignore the strength of domestic demand in order to shelter the exposed sectors. That would put the whole of the economy at risk to accelerating inflation - including those sectors we were seeking to protect. And it would not be of much help to them in anything other than the short term. The monetary policy option is - as I say - not whether or not, it is sooner or later, and ultimately less or more. The elements of hope that I can hold out to you - and central bankers can never give guarantees on this kind of thing - are first, that as we move into the euro process the markets will become increasingly persuaded that the ECB will, in fact, be committed to the stability of the new currency, as I am sure it will: and, secondly, that relative monetary conditions will change as activity picks up on the Continent and domestic demand moderates in this country. Our present exchange rate dilemma, Mr. Chairman, illustrates rather well the conflicting arguments about the euro project itself. The strengthening of sterling and its effect on the exposed sectors of the economy point up very vividly the very real advantages of the exchange rate certainty across the European Union area which only the euro can provide.
The growth of domestic demand is likely to be held back by the relatively tight fiscal policy as well as by the monetary policy tightening since May; and the effect this year of “windfalls” as a result of building societies’ demutualisations will be very much smaller. And we expect a deterioration in our net external trade position as a result of the strength of sterling’s exchange rate and now, too, as a result of the recent developments in Asia. The difficult questions for policy relate to the timing and the extent of the slowdown that is necessary on the one hand and likely on the other. These are difficult judgements at any time. They are particularly difficult when the economy is already close to full capacity. It is not surprising BIS Review 3/1998  -3-  that commentators differ in degree in their assessments. Economics is not - as I say - a precise science. Neither we at the Bank nor anyone else know with any great precision exactly where we are in relation to full capacity or exactly how fast capacity is growing; and we don’t know precisely either how demand will in fact respond to the policy tightening that is already in place. Our own best - and very carefully informed - guess is embodied in the forecasts that we publish each quarter, and we monitor immensely carefully the new information that becomes available day by day in the light of that forecast for early warning signs of emerging imbalance.