The time could not be better to start talking down the pound

Professor Peter Spencer Item Club's economic adviser

UK manufacturing output has been declining since the middle of last year and last month it suffered its sharpest fall since 1996.

The strength of the pound - which reduces the competitiveness of British exports - has made the plight of UK manufacturers worse than other countries also facing the global economic slowdown.

"The time could not be better for the Monetary Policy Committee to start talking down the pound, supporting the move by selling sterling in the exchange markets," said Professor Peter Spencer, the Ernst & Young's Item Club's economic advisor.

Interest rate difficulties

The Bank of England has tried to help manufacturers by cutting interest rates, thereby encouraging more spending and sending more business in their direction.

UK GDP growth

2000 3% 2001 2.5% 2002 2.1% 2003 2.8% 2004 3% 2005 2.6% Item Club forecasts

But this has also caused UK shoppers to build up increasingly worrying debt levels, causing the Bank of England to hint that it might have to curb consumer spending in the months ahead by raising interest rates again.

The Item Club warns that a false sense of security among borrowers may prolong the pain of any future financial crisis.

It is this split economy - where manufacturing is in decline but consumers are still spending strongly - that has led the Item Club to call for a change in monetary policy.

The two-speed economy has made interest rate decisions increasingly controversial over the past few months.

Inflationary pressure

"We cannot see any sense in using interest rates to stimulate demand.... when this would be better achieved through a lower exchange rate," said the Item Club.

UK manufacturing growth/decline

2000 1.9% 2001 -2% 2002 -1.9% 2003 1.9% 2004 3.3% 2005 2.5% Item Club forecasts

The think-tank points out that a weakening of sterling would pave the way for a smoother entry into the European single currency should that become one of the government's goals.

The disadvantage of a weaker currency is the risk of spiralling inflation.

But inflation is already subdued, being below the government's 2.5% target, though still within the 1.5-3.5% tolerance band.

The Item Club says sterling could fall by as much as 10% from its current value before inflation increases to more 2.5%.

Vital

The Item Club - which uses the Treasury's own model of the UK economy - has called on a weakening of sterling in previous reports, but now says that it is vital and that the time is better than ever.

The report also forecasts that the UK's economy will grow by about 2% this year, outstripping the growth of other members of the group of seven leading industrialised nations.

This estimate is at the bottom end of the Chancellor Gordon Brown's own estimate of 2-2.5%, but is more optimistic than some other independent forecasters.