Test of Nerve

The British have many sterling qualities, but right now sterling is not one of them. Just four months ago the pound was worth $2.02. Last week sterling tumbled no less than four cents against the dollar in a matter of a few hours. It dipped to a historic low of $1.705 before recovering its shaky moorings and closing at $1.7 16.

British officials called the fall an "erratic fluctuation." That view may be overly sanguine, but there was indeed no evidence, for the moment at any rate, of a massive flight from sterling. Yet the sudden plunge left no doubt about just how vulnerable the buffeted pound is to the gusts of the marketplace. The slide was touched off when Swiss banks, anticipating new import controls on foreign capital moving into Switzerland, converted sterling into the solid security of Swiss francs. Even this light selling wave was enough to tip the pound into its tailspin. Said one London currency dealer gloomily: "It's not so much that people are selling pounds. Nobody wants to buy."

While a cheaper pound lowers the price of British goods in world markets, and thus provides an incentive to lag ging British industry, it also fuels inflation by raising the cost of imported food and raw materials. One official calculation is that each drop of 4% in the ex change rate of sterling adds 1% to domestic inflation, thus threatening the recent improvement (the rate has dropped 6.6 points in the last six months, to an annual pace of 13%). Still, once the spin began, Prime Minister James Callaghan and his Chancellor of the Exchequer Denis Healey had little choice but to steel their nerves and let the drop in the pound run its course.

To brake sterling's slide through March and April, the Bank of England used up $2 billion in reserves, then borrowed from the International Monetary Fund in May. Almost certainly, further borrowings would only be available in return for a program of stringent cuts in government spending. Yet spending cuts would jeopardize the key element in the Labor government's strategy to pull Britain back from its economic abyss: an agreement by the leadership of the Trades Union Congress to hold wage increases to 4 1/2% ($4.61 on an average worker's salary) beginning Aug. 1 (TIME, May 10). In return, Healey offered a significant income tax break for lower-income workers.

Wage Restraint. The 11 million members of the T.U.C.'s constituent unions will vote next week to ratify or reject that agreement and, as Healey bluntly put it, more severe welfare cuts than he has already planned could "bust the relationship between the unions and the government." With minimal fanfare, in order to avoid upsetting the unions, the government has already put a tighter rein on municipal welfare spending, cut a scheduled pension raise by one-third, and indefinitely postponed a new child-benefit scheme. But Healey turned aside demands from the opposition Conservatives for more sweeping cutbacks with an admonishment that "the most important thing is not to panic and lose our nerve." More accustomed than most finance ministers to the uses of adversity, Healey was plainly counting on the slipping pound to help secure a resounding union vote for continuing voluntary wage restraint.

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