UK business shies away from pegging pound to euro at current level

Date: 12/03/1998

By Tim Jones

BUSINESS in the UK would rather see a fall in the external value of sterling than lock the currency at current levels against the euro when it appears in January, according to the Confederation of British Industry's chief economist.

This reduces the prospect that London will peg the pound against the euro next year in order to avoid British companies finding themselves at a disadvantage when bidding for contracts within the single currency area.

“One of the consequences of the coming of the euro is that British industry will face an exchange rate risk, but that might be something they just have to live with,” said the CBI's Kate Barker while on a visit to Brussels.

Soon after announcing in the autumn that the UK would not join monetary union until 2001 at the earliest, Finance Minister Gordon Brown warned British firms that they would soon be competing for cross-border contracts with companies that faced no exchange rate risk whatsoever.

Barker nevertheless insists that the CBI's members would not be interested in a deal to peg sterling to the euro at a fixed rate - the kind of agreement Denmark is hoping to reach with the European Central Bank - unless this is a prelude to membership of EMU.

“A lot of industry is still scarred by the experience of the Exchange Rate Mechanism,” she said. The UK was forced out of the ERM - a system of semi-fixed exchange rates - in September 1992 after two years and one deep recession.

“They will only press for a peg when they think that EMU membership will come shortly afterwards. If, for example, membership were coming in 2001, then a peg in 1999 might be acceptable but not, I think, otherwise. Nobody would have the stomach to sustain a bilateral peg otherwise.”

With sterling still trading at around three deutschemark, big exporters claim that their products are increasingly uncompetitive in price compared with those from European rivals. Last week, the UK Steel Association wrote to Brown warning that sterling was “overvalued and seriously affecting the future success and competitiveness of UK manufacturing and the steel industry in particular”.

Barker can offer them little solace at the moment. “I am not optimistic about sterling coming off the boil very soon,” she said. “I think it will stay high until the markets see the whites of the eyes of the European Central Bank and how credible it is in policy terms. But it is possible that we could get into 1999 with a broadly satisfactory rate - something around the 2.60-mark area, which could be anything between 2.55 and 2.70.”

She believes that the long British boom will begin to slow in the second half of this year, which could depress sterling to 2.80 marks by January. However, interest rates, now standing at 7.25&percent; compared with 3.30&percent; in Germany and France, will stay high to discourage domestic demand.

“This was the main reason business accepted that it would be impossible for us to join EMU in 1999; because it was seen as impracticable to get interest rates down to a sustainable level without a huge shock,” explained Barker.

Establishing a sterling peg while interest rates in the UK and the euro-zone are so divergent could lead to economic distortions, she warned. “If you take all the uncertainty and risk out of the exchange rate, then you can get it elsewhere.”