Case Number Four: The Euro Reacts to New Information

According to an article in the Wall Street Journal (October 8, 1999):

The European Central Bank left interest rates unchanged but made clear it is seriously considering tightening monetary policy. The euro fell slightly on the ECBs announcement around midday that it would hold its key refinancing rate steady at 2.5%. But it rebounded as ECB President Wim Duisenberg reinforced expectations that a rate rise is in the works.

In the same story, the Wall Street Journal reported that the Bank of England didnt elaborate on its decision to leave its key repo rate unchanged at 5.25%. At the same time, sterling remains strong, which reduces the threat of imported inflation as well as continuing to pressure U.K. manufacturers. That could work against higher interest rates, which could send sterling even higher.

Required Questions

1. Explain the differing initial and subsequent reactions of the euro to news about the European Central Banks monetary policy.
2. How does a strong pound reduce the threat of imported inflation and work against higher interest rates?
3. Which U.K. manufacturers are likely to be pressured by a strong pound?
4. Why might higher pound interest rates send sterling even higher?
5. What tools are available to the European Central Bank and the Bank of England to manage their monetary policies?