Posts Tagged ‘pound sterling’


The pound fell to a three year low against the dollar this week. At the time of writing there are 1.4949 dollars to the pound, and many have hit the panic button. They say a crash in sterling is in sight. Are they right?

The current dollar pound exchange rate is low, but it’s far from being a record. It was lower in 2009, and in the mid-1980s went close to parity with the dollar. There are two reasons to fear for sterling, and indeed the consequences of a fall in the pound. But there are reasons for less pessimism, indeed even optimism too.

Reason number one is the Fed. If good news on the US economy continues it has said it will start cutting back on its quantitative easing programme this year, halt it altogether next year, and up interest rates in 2015. If this is indeed how it pans out, as US rates rise, money might well flow into the US from the rest of the world. Many central banks may respond by upping rates.

Because of the high level of household debt we can’t really afford higher interest rates in the UK. The Bank of England may have to choose between upping rates to stop a rout on sterling, but creating massive hardship for households with high debts in the process, or just accept a much cheaper pound relative to the dollar. Just bear in mind, however, that this problem is not unique to the UK, and if rates rise in the US, the pound may fall relative to the dollar, but stay firm relative to other currencies, such as the euro.

Reason number two is more serious. In the UK we are used to imports of goods and services being greater than exports, but at least income from investments flowing into the UK tends to be greater than income flowing abroad. But there are signs that this is changing. The UK’s net investment income has been negative in three out of the last four quarters. The story here is complicated.

The value of investments held by foreigners but relating to the UK is much greater than British investments abroad. But UK investments held abroad tend to be higher risk, and generally provide a much higher return; there are signs this is changing, however, and that is a worrying development.

To be clear, if net investment income continues to be negative this will put pressure on sterling relative to most foreign currencies, not just the dollar. On the other hand, a cheap pound may be good for exporters, although it will be bad for inflation, and may extend the period of time in which wage increases lag behind inflation.
But this may not occur, not at all.

Take the latest trade data. In the latest three months the value of exports to China was 17 per cent per cent higher than the average 2012 quarterly level. Import values from China were little changed, so the trade deficit with China, which had averaged £5.2 billion a quarter in 2012 shrank to £4.8 billion in the last three months.

Historically, the UK runs a trade in goods surplus with the United States. That rose in the latest three months. The value of exports was 5 per cent higher than its average 2012 level, while imports fell by 8 per cent. In the three months to the end of May, exports to non-EU countries increased by £1.7 billion while imports increased by £0.9 billion.

There is another reason for optimism, there signs that the UK is on the march to recovery. See: UK recovery: the reasons why and why not 

There is one big danger however. The UK does suffer from a disease. For too long money has flowed into supporting the housing market – though not house building – but there are few signs this is changing.

Remember, the strength of sterling tends to tell us how strong the economy is. If the economy does well sterling usually rises. In a way, the value of the pound is like the UK’s share price.

Right now, company cash holdings sit at around 20 per cent of GDP or at a 25 year high. If this money is used to fund investment, then the UK may boom. If instead, companies hoard their cash, banks focus on parking cash sitting in deposit accounts in mortgages, and the government focuses on trying to get house prices rather than investment up, the UK’s share price – or if you prefer to put it these terms, the value of the pound – will come under new and prolonged pressure.

© Investment & Business News 2013

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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