The strength of sterling continues to put pressure on the pound. Yesterday the pound fell to its lowest level against sterling for around six years, while it continued to reach new highs in the ERM band. The weakness of the pound against sterling is very good news for Irish exporters to Britain; many of these endured great difficulties during the 1992/93 currency crisis but current circumstances could scarcely be more favourable with Irish exports trading at very competitive levels in the British market. The situation is not so favourable for those travelling to Britain for business or for holidays. While the pound has fallen against sterling, it remains very strong against the other ERM currencies. Some Irish exporters, which are heavily dependent on the Continental market, are finding their profit margins squeezed, as the continuing rise in the pound against other ERM currencies makes Irish exports less competitive in key EU markets. Indeed, the pound is now moving towards the kind of trading level that is uncomfortably close to the upper limit of 15 per cent in the ERM. The current value of sterling owes something to the renewed strength of the British economy, but also to the expectation in the markets that British interest rates will rise as the Bank of England moves to dampen inflationary pressure. It may be that sterling also provides a safe haven for investors at a time when the overall outlook for European monetary union continues to be uncertain.
In the short term, policymakers in this State would be best advised to sit tight and await developments. But some awkward policy dilemmas might present themselves if sterling's current strength endures, notably in relation to EU monetary union which is scheduled to begin in January 1999. Although the rate at which currencies lock irrevocably together has still to be fully determined, it is quite likely that the central ERM rate will be used. As the pound is now trading well above its current central rate, this creates obvious problems for the management of the Irish currency in the run up to monetary union.
One risk is that a wave of speculative selling hits the pound. If investors are convinced that the pound is trading in the ERM well above the rate at which it is likely to join the monetary union, there is an incentive to sell and make a quick profit. Allowing the value of the pound to fall sharply carries others dangers; higher import prices would create new inflationary pressures in the economy. However, moving now to re-value the pound's central rate upwards in the ERM in anticipation of the currency joining monetary union at a level above its existing central rate would also be risky. The danger would be that a subsequent collapse in the value of sterling would leave the pound dangerously overvalued. So the best strategy for the moment appears to be to hope that sterling starts to run out of steam. If it does not, then the Government and the Central Bank will face difficult policy options.