Pound ‘buying less than a Euro’

Question is: how far can the pound sink?
By Chris Giles
Financial Times, 13 December 2008

In a week when sterling’s performance has not been nearly as bad as its press, the big question is: how low can the pound go?

Last Friday, the trade-weighted sterling index stood at 79.8. Over the past week, its value has fallen sharply against the euro, but risen strongly against the dollar. On a trade-weighted basis, the pound closed on Friday at 78.8. It was not a great week, but nor was it a disaster with a fall of 1.25 per cent.

The trouble is that over recent weeks, sterling has suffered many of these mild declines. Lots of small falls add up to depreciation of more than 20 per cent.

Apart from making skiing ever more a pastime for the well-off, the issue of currency has long had the ability to strike fear into British politicians. From Churchill and the move back to the gold standard in 1925, through the devaluations of Harold Wilson in 1967 and John Major in 1992, to Tony Blair’s flirtation with the euro, sterling has regularly been a flashpoint for British politics and economics.

The architects of inflation targeting – Norman Lamont, the chancellor between 1990 and 1993, and Mervyn King, the Bank of England governor – had hoped this difficult history would be consigned to the past. And for most of the past 16 years, they have been right.

The establishment still see the currency within the prism of the past 16 years. Publicly, the Treasury is adamant that sterling should be allowed to move because, as Dave Ramsden, the Treasury’s chief economic adviser, told the Commons’ Treasury committee this week: “We know that the government does not have any kind of policy or target towards sterling.” Privately, Treasury officials say the same, but even more forcefully.

Most officials in the Treasury and Bank of England are happy the pound is sinking, thinking it will limit the depth of the recession. Their view does not come from a Panglossian belief that exporters will suddenly fill all the empty trucks leaving Dover harbour, but from the belief that fewer fully-laden ones will arrive.

The pre-Budget report cheerfully conceded that “the short-term boost to export volumes may be limited”, but added that “sterling’s depreciation is more likely to support a positive contribution from net trade to UK gross domestic product growth via the negative impact on import growth”.

But this argument has a limit even at times of few inflationary concerns. Charlie Bean, Bank deputy governor, told the Treasury committee last month the 20 per cent depreciation was “the right order of magnitude”. But he raised a scenario that scares policymakers.

“An alternative scenario,” he said, “is one where external investors lose faith in the policy framework that the UK operates under and expect much faster rates of inflation in the future or something like that which results in downward pressure on sterling now – an old-fashioned sterling crisis.”

Mr Bean made clear he did not believe Britain was anywhere near a sterling crisis and there is precious little evidence investors think it is either. In the thin credit default swap market, the cost of insuring government debt has risen steeply, but remains at a very low level. The movement of government debt yields have been comparable with those in Germany. That is the good news. The bad news is markets rarely signal developing concern in advance. If a sterling crisis arrives, do not expect a warning.

Copyright The Financial Times Limited 2008

Pound falls towards euro parity
By Esther Bintliff
Financial Times, 13 December 2008

Sterling plunged towards parity with the euro this week, as the rapid deterioration in economic activity prompted talk the UK could face a currency crisis.

The pound fell 1.2 per cent against the euro to touch a new all-time low of £0.8997 Friday in its fifth consecutive session of losses, bringing its decline on the week to 4.3 per cent.

Sterling’s trade weighted exchange rate index also hit a historic low, sinking to 78.8, its weakest level since records began in 1981.

An onslaught of bleak economic data exposed the depth and severity of the UK recession and savaged confidence in the pound.

Jessica Hoverson at MF Global said: “I wouldn’t be surprised to see parity by the end of the year. The fundamentals in the pound are so dismal and trading momentum for the euro is incredibly bullish.”

But Ian Stannard at BNP Paribas warned that the euro would not be immune to worsening conditions in the eurozone.

“We expect the euro rally against the pound to run out of steam as the euro becomes exposed to the deteriorating picture in Europe,” Mr Stannard said.

Eurozone industrial production fell 5.3 per cent year-on-year in October, the sharpest decline since July 1993.

Following the release of the bleak data, the euro slid 3.8 per cent against the yen to Y117.76, before clawing back its losses to trade down 0.1 per cent at Y121.98.

Overall the euro gained 3 per cent on the week, boosted by hawkish comments from European central bank policymakers that suggested rates would not be cut in January.

The euro also rose 0.2 per cent against the dollar to $1.3380, bringing its gains on the week to 5 per cent, as the failure of the US carmaker rescue plan sent shockwaves through global equity markets and forced the dollar downwards.

The dollar plumbed a 13-year low against the yen Friday, plummeting 3.7 per cent to Y88.34.

The greenback later steadied at Y91.28, down 1.7 per cent on the week, but the puncturing of the psychologically significant Y90 level intensified speculation that the Bank of Japan could be forced to intervene to slow the yen’s rapid appreciation.

The Japanese currency has rocketed 17 per cent against the dollar since August, undermining the competitiveness of Japan’s exporters. Analysts warned that next week’s Tankan business survey was expected to be exceptionally grim, raising pressure on the government to prop up the economy.

But conflicting comments from Japanese officials left the prospects for intervention unclear. Naoyuki Shinohara, foreign exchange minister, said the yen’s moves were excessive and that the ministry would act “appropriately” depending on the situation. But Shoichi Nakagawa, finance minister, said that Japan was not considering intervention yet.

Simon Derrick at BNY Mellon commented: “Given that the all-time lows from April 1995 (just below Y80) are now coming into sight, Mr Nakagawa’s comments seem to display a surprisingly sanguine attitude.”

Even as equity markets sank Friday, the greenback failed to recover its poise against high-yielding currencies, leading analysts to suggest the recent correlation between risk aversion and dollar strength had been weakened by the US-specific risks of the carmakers collapse.

Copyright The Financial Times Limited 2008

The pound in your pocket: a new era?
Financial Times, 13 December 2008
Editorial

“From now the pound abroad is worth 14 per cent or so less in terms of other currencies. It does not mean, of course, that the pound here in Britain, in your pocket or purse or in your bank, has been devalued.” Back in 1967, the concept of devaluation was strange enough that Harold Wilson, the British prime minister, felt obliged to explain what it meant.

It is not quite so hard to grasp these days. Sterling has recently fallen by rather more than 14 per cent – on a trade-weighted basis it has dropped 20 per cent over the past year, and 5 per cent in the past fortnight. The pain will be obvious enough to British skiers in the alps this winter, but even the stay-at-homers will feel the effects. Plunging energy prices and the equivalent of a global closing-down sale are putting downward pressure on prices. But thanks to the slump in sterling, British consumers will find that the prices of Belgian beer, Chinese toys and Japanese cameras do not fall as reliably as they might have been led to expect.

Sterling may even be entering a new era, as it did in 1967 and at the end of the 1970s. Three decades ago, the pound soared as North Sea oil began to flow. Since then, sterling’s strength has been closely tied to domestic oil production. Since the late 1990s, that production has fallen by more than 40 per cent. Sterling was supported for a while by earnings from the booming financial services sector, the City being something of an oil well in its own right. But after the credit crunch, it is not clear how fully and how quickly the City will recover.

Some argue that sterling is unlikely to fall further: whether against the euro or against the basket of currencies that preceded the euro, five decades of data show that sterling has never been weaker. Yet that can hardly be guaranteed; on a trade-weighted basis, sterling was weaker in the 1970s, when neither oil nor banking were propping it up. Certainly, there is plenty of scope for the UK economy – with its unusually large financial sector, housing bubble and household indebtedness – to struggle yet further relative to others.

Grim as this might seem for those who view a nation’s currency chiefly as a virility symbol, the fall in sterling is not a problem for the UK economy: it is a symptom and even a solution, helping UK plc to begin the necessary process of spending less and selling more exports. Not that a weak pound is a cure-all, because export markets are currently so weak.

And sterling’s fall will cause headaches. From the UK’s perspective, the main fear is that the fall in sterling spooks buyers of UK government debt. There is little sign of that, yet. The UK’s trading partners may also be aggravated at a time when everyone is urging everybody else to buy each others’ exports.

For all its importance, sterling’s fall need not provoke a frantic policy response. The Bank of England may be less eager to cut interest rates further, partly to avoid a collapse in the pound and partly because a weak pound is a substitute for low rates. That is about it. The pound may fall further, and the UK authorities can sit and watch.

Copyright The Financial Times Limited 2008