Weak pound may raise inflation, O'Connell warns

ANY significant weakening of the pound against sterling could lead to an increase in the rate of inflation, the Governor of the Central Bank, Mr Maurice O'Connell, has warned.

Addressing the European Finance Convention in Dublin on EMU and Irish Monetary Policy, Mr O'Connell referred to the recent strengthening of sterling against the pound.

"While this may bring certain benefits for exporters, at least in the short term, any significant weakening of the Irish pound against sterling would have potential inflationary implications," he said.

This is the first time the bank has commented directly on the implications of a fall in the pound against sterling for Irish inflation. The bank has intervened in the markets to support the pound from falling through parity with sterling in recent weeks.

Looking over a longer period, the pound has been generally gaining ground against sterling, leading to complaints from exporters.

Mr O'Connell said there was "no hard evidence" that the 7.5 per cent appreciation of the pound over sterling, over the three-year period to October 1st had "damaged even the most vulnerable sectors of Irish industry".

The increase was a test of strength for exporters to Britain but it had been gradual. Exports to Britain remained quite buoyant, he said.

The Minister for Finance had stated consistently that a priority of exchange rate policy was a comfortable position within the exchange rate mechanism (ERM),

Mr O'Connell said.

"In aspiring to EMU, this is a priority and it is the duty of the Central Bank to ensure that this policy is implemented. This implies a close and stable relationship with the other currencies in the ERM.

"At the same time, while any residual uncertainty about the EMU timetable remains, movements in sterling impact on the Irish pound."

There has been speculation about the bank's policy recently as it allowed the pound to rise against the deutschmark rather than fall further against sterling. However, the governor said: "We do not adopt a specific target position against sterling or any other currency and I would like to underline this."

Ireland would prefer if Britain joined the EMU at the outset. However, on present evidence it would "seem wise" to make preparations on the basis of Britain remaining outside, at least initially. There would be a price for this, he said, "especially if sterling were to fluctuate substantially against the euro".

Mr O'Connell said there was no certainty, but EMU should offer low inflation and lower interest rates.

Giving mixed signals on interest rates, he said that "as we move close to EMU, we would obviously expect the differentials between Irish and ERM rates generally will narrow". While in the EMU Irish short-term rates will be the same as others members of the union. But, he added that a consequence of the recent strong performance of the economy has been a surge in credit somewhat beyond what we would consider preferable.

This "has had an upward influence on interest rates," he said, adding that he would make no predictions about future trends.

Turning to the overall impact of EMU, he said there "is perhaps a residual worry that excessive discipline might stifle growth but the powers that be in Europe are also pragmatic. There is perhaps some room for concern that union might condemn the less well off and peripheral regions to second class status". In response to this concern it is fair to point to the excellent record of the European Community in promoting the development of the regions, Mr O'Connell said.

There was little evidence of an early solution to European unemployment. Some people argued that adherence to the Maastricht Treaty criteria was damaging product ion and employment but there was no hard evidence.

"If satisfying the criteria encourages responsible macro-economic management, then surely this will be conducive to long-term economic growth," Mr O'Connell said.