Central Bank coy on plans for the year ahead

The Central Bank's key monetary policy statement may have been a long goodbye as it prepares to cede control to its European successor upon the advent of monetary union but it did little to shed direct light on what the Bank plans in the year ahead.

Reading between the lines, however, one thing is clear. The Minister for Finance, Mr McCreevy, has not done any deal on the revaluation of the currency. And to the extent that a cautious institution such as the Central Bank can, it is playing hardball.

The Central Bank, possibly under pressure from its European counterparts, is putting Mr McCreevy under pressure to state whether or not he intends to revalue the pound. The absence of such a statement will probably be seen as a recognition that the pound will enter the new euro zone at its current central rate.

Nevertheless, according to Mr Jim Power, chief economist with Bank of Ireland, the revaluation story is likely to continue to rear its head and the currency to seesaw between now and the announcement of the terms of monetary union in May.

The other possibility is that the bank itself will attempt to send a strong signal by intervening in foreign exchange markets to prop up the pound in the days ahead.

This may be unlikely as the Bank lost significant amounts the last time it tried to buck the markets in 1997. In any case, if Dame Street is planning such a move, it will have to happen soon. The pound has lost 2 per cent in trade-weighted value over the past two days and is likely to fall further today.

If it falls significantly further, it will prove very difficult for Mr McCreevy to order a revaluation.

There is also a possibility that the Minister has been getting different signals from some of his key advisers in recent days.

The chairman of the US Central Bank, the Federal Reserve, Mr Alan Greenspan, warned just last week about the possible global disinflationary impact of the ongoing Asian currency crisis.

In a situation where many of the world's currencies may be set to devalue, Irish authorities are not quite as keen to actually increase the value of our currency.

Recent job losses in high technology areas have also underlined many of these fears.

The clear message is that unless there is a statement from Mr McCreevy or intervention from the Central Bank over the course of this week, it appears virtually certain the pound will undergo further selling and may even approach DM2.41. This may have an inflationary impact.

Of course, the key role for the Central Bank in terms of its responsibilities is interest rates. There were few clear statements on rates in the Bank's bulletin. The paradox is that the fate of interest rates is determined by the exchange rate - which the Bank did not mention.

This absence of a clear statement is interpreted differently by various analysts. Mr Power said he now believed the Central Bank would attempt to hold off interest rate cuts for as long as possible. "What is certain is that we will have rate cuts of two percentage points," he said. "But they are not necessarily coming any sooner than we believed before."

However, both Dr Dan McLaughlin, chief economist at Riada Stockbrokers and Mr Dermot O'Brien, chief economist at NCB Stockbrokers, believe that, once the currency has settled at a sustainable level, the flows into the pound will be so substantial that interest rates will have to fall.

The Bank admits it is likely that rates are set to "decline significantly". However, it added that the precise evolution remained uncertain and that the strength of the economy justified caution.

Ironically, in the short-term, the Bank remains in a good position. Substantial selling of the pound withdraws liquidity from the market and thus keeps rates up. However, as soon as buyers step in, this will reverse and the Bank could come under pressure. After earlier bouts of selling in 1997, the market is thought to be very "short" and thus may have a desire to buy pounds back at a significantly lower price. According to Mr Power, there may be as much as £1 billion waiting for the currency to reach about DM2.48.

One problem is the possible impact this will have on inflation. Few analysts are in any doubt that an economy growing at around 10 per cent, undergoing a 10 per cent currency drop and a two percentage point drop in rates as well as an expansionary budget can expect to a pick-up in inflation.

According to Dr McLaughlin, there is little the authorities can do in any case at this stage. A revaluation might mean that not as much inflation would feed through, but the existing falls in the currency would fuel an increase in any case. He maintained that inflation may not be very a serious problem so long as the national wage agreement was adhered to. However, Mr O'Brien warned that the pick-up in inflation could nevertheless be serious enough to jeopardise the terms of the agreement.

That would be one consequence which neither Dame Street nor Merrion Street would be keen to see.