Sterling Signs: Good & Bad

Every Thursday morning, in a ritual as fixed and revered as the changing of the guard, the Bank of England's 18 di rectors meet behind its Corinthian col umns and mahogany doors to plot their strategy for protecting the pound. In measured tones, they debate how much money to borrow in the domestic mar ket, whether to buy or sell sterling in foreign markets and -- most important --whether to change the bank's interest rate. After each meeting the chief liai son man, Peter Daniell, dons his top hat, starts on a 21-minute walk across Bartholomew Lane in London's City. Precisely at 11:47 a.m., he marches into the stock exchange and, while bro kers crowd around him, announces the bank rate -- the price of money.

Last week Daniell had good news: the Bank of England cut its interest rate from a forbidding 7% , which had pre vailed since last November's pound cri sis, to 6% . While the lower rate will tempt some international speculators to shift their money out of British banks, the government hopes that it will also stimulate the economy sufficiently to at tract other deposits. The Bank of Eng land's directors felt confident enough to take that risk because British reserves are strengthening; last week the Treas ury announced that the sterling area's gold and foreign currency reserves rose $165 million in May, to a two-year high of $2.9 billion. By week's end the pound rallied on the world money markets and climbed to within a fraction of its $2.80 par value.

Rough Road. Despite the rebound, Britain's economy faces a rough road this summer. British tourists will soon begin their annual exodus abroad, cut ting into Britain's reserves as they eat and drink their way across the Conti nent. A bigger worry to Britain's money managers, however, is the extent to which the country's reserves will be drained by its staunchest foreign allies in the monetary battles--the nations of the sterling area.

Banded together in the area are 45 countries--the Commonwealth and its traditional trading partners--as disparate as Jordan, Iceland, Pakistan, Eire, Ghana and South Africa. They invest most of their own foreign-exchange holdings in British gilt-edged bonds, thus swelling the reserves that Britain can use to defend the pound. When these countries run into deficits in their foreign trade, which happens particularly when commodity prices drop, the situation changes: the sterling area members cash in their bonds and thus pull down Britain's reserves. This is precisely what occurred this year; so far, the sterling nations have reduced their British-held balances to a two-year low of $225 million.

Britain's powerful bankers have no control over the factors that caused this decline: a 22% drop in the price of Australia's wool, a 33% plunge in the price of Ghana's cocoa, a surge in India's food imports. Ironically, the sterling area's ailments have been aggravated by Britain's attempts to buttress the pound and by the U.S.'s program to end its own payments deficit. Because of the cutback in U.S. and British loans and investment, Australia's reserves fell from $2 billion in January to $1.5 billion in May. India's reserves are down to an alltime low of $171 million, and the country is amid a financial crisis.

Big Question. If the sterling area drain grows worse, as it is expected to later this year, Britain can call up further defenses for the pound, probably including the assistance of the International Monetary Fund. London has closed a deal with the U.S. to swap $750 million worth of pounds for dollars in a pinch, and it still controls $1.25 billion worth of U.S. stocks and bonds that can be converted into dollars. But the big question remains: can Britain ultimately prevent devaluation? To do that, it must hold down prices, expand productivity and make its exports more ' competitive in world markets.

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