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MINUTES OF THE MEETING OF THE MONETARY POLICY COMMITTEE HELD ON9-10 FEBRUARY 2000

1 Before turning to its immediate policy decision, the Committee discussed money, credit and asset prices, demand and output, labour market conditions, the world economy, and prices and costs; reviewed the February projections for output and inflation; and considered the implications of sterling's further appreciation and the continuing imbalances in the economy for its policy decision.

Money, credit and asset prices

2 Sterling's effective exchange rate index (ERI) had been volatile, moving in a range of 106.7 to 110.6 in the 15 days up to the meeting. It had risen by about three quarters of a percentage point since the Committee's January meeting, and the 15-day average used as the starting point in the February Inflation Report projections was about four percentage points higher than that used in the November projections. This rise in the ERI was accounted for by an appreciation against the euro which could not be explained by changes in interest rate differentials. 3 The Committee discussed whether sterling's strength might be explained by a rise in the medium-to-long run equilibrium real exchange rate against the euro. There might have been such a rise if, for example, UK production had become more competitive relative to the euro area, perhaps on account of greater market flexibility and/or more widespread application of new technologies. But, at least as yet, there was no sign of this from the performance of the trade equations in the medium-term macroeconomic model, and it was difficult to identify news over the past few months suggesting that the long-run equilibrium exchange rate had changed. 4 Another possibility was that there had been a change in the risk premium, with sterling regarded as having become less risky relative to the euro. The change to the UK's monetary framework and/or, for example, uncertainty about structural reform in parts of continental Europe could, in principle, have brought that about. It was, however, highly uncertain whether this was a material part of the explanation of sterling's recent rise. 5 If sterling had risen on account of a change in the risk premium, what would that imply for the path of the exchange rate looking forward? A number of possibilities were identified. First, a reduction