Edited highlights from the Chancellor's letter

EXTRACTS of the letter from the Chancellor to John Watts, chairman of the Treasury and Civil Service Committee.

Exchange Rate Mechanism

The Government has made clear its intention to resume Britain's membership of the ERM; but it will do so only when a number of conditions have been satisfied (these include):

. . . an end to the current turbulence in the foreign exchange markets;

. . . there should be reflection and analysis on developments in the markets and the ERM;

. . . the requirements of German monetary policy and those of the UK must come closer in line. The present wide differential in interest rates between Germany and the US . . . will need to narrow.

Inflation objective

. . . we should aim at underlying inflation, measured by the change in retail prices excluding mortgage interest payments, matching the best in Europe . . . in the long term 2 per cent or less.

For the remainder of this Parliament, underlying inflation should be within a range of 1-4 per cent. By the end of the Parliament, we need to be in the lower part of the range.

Monetary policy

. . . I will take into account a wide range of factors. My aim will be to reach a judgement on inflationary trends and whether the Government's objectives are likely to be achieved.

Exchange rate

I wish to make clear that I have not set a target range for the exchange rate, nor is there a value which is being shadowed. Equally I should make clear that I do not propose to adopt a policy of setting interest rates in relation to domestic criteria and then letting the exchange rate go where it will.

Domestic indicators

I have already set a target for M0 for this year of 0-4 per cent. The latest figures show growth close to the centre of the range. It would be helpful to give some idea of the growth of M4 beyond which there would be increasing cause for concern. These might be termed monitoring ranges.

There are other useful indicators of inflationary expectations derived from various market rates of interest . . . and from the behaviour of asset prices, particularly house prices. I propose to monitor all of these, paying particular attention when house prices are falling or rising sharply.

Fiscal policy

If industry is to be able to take advantage of the opportunities which the lower exchange rate has now presented, it will be essential to keep tight control over public spending and borrowing. As part of this, the Government will be seeking to maintain firm downward pressure on the growth of public sector pay.

Explaining policy

It will be important to explain clearly to Parliament and the markets how we assess the progress being made towards the Government's inflation objectives.