Europe's influence on our interest rates cannot be ignored.
The Government, as ministers like to remind us, has, since last autumn, been pursuing a British monetary policy to suit the needs of the British economy. Put like that, the idea is simple enough. During the 23 months that sterling was in the European exchange rate mechanism (ERM), policy became increasingly geared to maintaining the pound at what many would regard as an unrealistic level, to the detriment of conditions at home. Since leaving the ERM, the balance has shifted almost entirely the other way.
It is easy, when living through it, to regard the highly unusual as commonplace. But one does not have to stand back too far to see the special nature of present circumstances. Britain's British monetary policy is a rarer animal than first appears, for two reasons.
The first is that it is a non-European policy. By this I mean, not simply that we have left the ERM or that our well-known reservations towards Maastricht and monetary union have come to the fore. The distinction is more fundamental than that. Other countries that have succumbed to the hurricane forces which have blown through the ERM in recent months have had to depreciate or devalue their currencies. But these countries have not broken free of the Bundesbank's iron grip on interest rates in the way that Britain has. Its non-European policy of low interest rates and a floating currency is as remarkable in its way as was Switzerland's negative interest rates during the safe-haven period in the 1970s.
And, moving on to my second reason, it is important not to fall into the trap of believing that, only when sterling was in the ERM did Britain play by the European rules. Long before membership, the influence of Europe was there.
Germany set the interest rate and inflation standard for the rest of Europe to try to emulate. The fact that, before the current episode, the only modern example of British interest rates falling below German levels was as long ago as 1981, and then only briefly, proves the 18e point. The key question is: can it last? Can Britain continue to pursue a non-European monetary policy indefinitely? To answer this, we must also look at things from the European side.
Britain's current monetary policy emerged, like many good things, by accident. Had sterling not been forced out of the ERM last September then, presumably, we would still be playing by those rules. Britain was a prime candidate for such a forced change of policy through having a deeper and longer recession than anyone else.
Now, if the policy shift brings with it the beginnings of a return to normal, which means above-trend growth in Britain's recovery phase, then the economic argument for our being out on a monetary limb will start to diminish. This would be particularly the case if recovery brings with it higher inflation, a sharply widening current account deficit, or both. We must be close to the low-point of Britain's interest rate cycle. Thus, even if German-controlled European interest rates were to remain where they are, British interest rates would, in time, rise up to meet them.
But clearly, European interest rates are unlikely to remain where they are. When German rates fall, as they have already begun to do, the full extent of the fall could be quite dramatic. But suppose the Bundesbank does not feel able to ease its grip on the monetary reins until well into 1994, or even 1995. Britain would then appear to be in a very good position. One could envisage a situation where funds are attracted to a growing British economy, and away from recession-hit Europe. It is possible, but it is unlikely. For one thing a grim German interest rate outlook would probably force the hand of the French government, as well as other committed ERM adherents. They would soften or break the link with the Deutschmark and lower their interest rates.
The Government's British monetary policy means, for the moment, lower interest rates than the rest of Europe. Later, it will mean a return to the normal position, where rates in Britain are generally higher than those on the Continent. We should enjoy our post-ERM honeymoon while it lasts.