Sterling’s slide: the why, wherefores and nonsense

Posted: February 25, 2013 in Currencies, UK Economy
Tags: , , , , , , , , ,

Woe is us. The pound is crashing. You would need to rewind the clock back all the way to October 2011 to find the last time the sterling euro exchange rate was so low, or so was the case at 9.30 am 25 February 2013. Come to think of it, October 2011 wasn’t actually that long ago. But hey, let’s not ride against the tide, the media says the pound is crashing; that this is bad, so let’s run with the crowd.

Except before we do that, let’s turn to the minutes from the Bank of England’s MPC published a few days before Christmas last year. The minutes stated: “The gradual appreciation of sterling between mid-2011 and mid-2012, as prospects for the euro area had deteriorated, had been unwelcome.” Errr what was that? The appreciation of sterling has been “unwelcome.”  Can you say that a rise in the pound is bad, and a fall in the pound is bad? Does that add up?

The minutes continued: “Although the nominal effective exchange rate remained well below its pre-crisis level, some measures of sterling’s real exchange rate provided a less comforting view of the improvement in UK competitiveness. In particular, a measure  based on relative manufacturing unit labour costs was now only 10 per cent below its level in 2007, and just  5 per cent below its average in the decade prior to the depreciation. It was therefore possible that the real exchange rate consistent with current account balance might be lower than its current value.”

Let’s put it this way, back in December, the MPC had a wish for a Christmas present. Their letter to the man in Lapland said: “Dear Santa, please may I have a cheaper pound”.  Their wish was not granted in one go. But it has been granted in stages. Sterling fell in January, stayed pretty static for the first half of February, then – after Moody’s cut the UK’s triple A credit rating – fell some more.

From the point of view of UK plc we may be getting the best of both worlds. Because of all that talk of currency wars at the recent G20, neither the UK government nor the Bank of England are allowed to deliberately push the pound downwards. Well there is no need. Moody’s is doing the job instead.

All praise be to the credit ratings agencies.

Some say that this shows the UK is bankrupt; on the road to ruin. Why can’t we do things like Japan, which lost its triple A credit rating years ago, or the US, or France, both of which lost their top notch rating some time ago.

It is embarrassing for poor old George. Mr Osborne invested a lot of political capital in saying he had to follow the policies he was adopting in order to avoid the disaster of the UK losing its triple A rating. Now that rating is lost, it is quite hard for him to say: “it doesn’t matter.” Although in truth it probably doesn’t.

In part sterling’s fall is down to the view that other economies are picking up. The Fed has hinted that QE may be drawing to a close; China’s central bank is tightening monetary policy. The markets still seem to think, somewhat inexplicably, that the euro is past its worst.

Talking of inexplicable, some economists think the key to the UK’s recovery is lower inflation, so that wage growth outpaces growth in consumer prices. Others think the recovery lies with a cheaper pound giving exporters a lift. But since a falling pound will lead to inflation, you can’t have both.

The trouble with the UK exporting its way out of trouble is that such a strategy can only work if firstly, UK exporters combine their terms of trade advances with investment and productivity improvements, and secondly if demand abroad is growing.

The first condition requires more investment – something the banks seem unable to promote. Unless QE is directed more precisely, and targeted in the form of investment in companies, especially exporters and innovators, the first condition probably won’t be met. As for the second, there is nothing, absolutely nothing, that either the Bank of England or George Osborne can do about that.

©2012 Investment and Business News.

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