THE RISING pound is causing some concern. “City squeezed by stronger pound” proclaimed the headline in Monday’s City A.M. – reporting the impact of sterling’s rise on the translation of overseas profits. There have also been worries that a rising pound could stifle the recovery of manufacturing output and exports.
So what are the facts? Over the past 12 months, the pound has risen by around 7 per cent on average against our trading partners. Sterling has appreciated most against emerging market currencies affected by concerns about their economic and financial stability – such as the Indian rupee and the South African rand. It has risen by about 10 per cent against the US dollar and better quality emerging market currencies, like the Chinese yuan. And there has been relatively little appreciation against our main trading partners in the euro area – with the pound up by just 3 per cent against the euro since last spring.
However, in historical context, the pound still looks very competitive. The recent 7 per cent rise should be seen against the 20-25 per cent fall in sterling during the financial crisis. A further 14 per cent rise would be required to get back to the average 1980-2007 value, with a 20 per cent plus increase needed to get the pound back to its pre-crisis value in summer 2007.
There are other reasons why we should not fear a stronger pound and – as long as it does not go too far – welcome it.
First, the recent strength of sterling reflects improving sentiment about the UK economy. As Tuesday’s GDP figures showed, the UK’s recovery now appears to be broad-based and the IMF has suggested our economy could be the strongest growing in the G7 this year. While some short-term factors – like the strength of the housing market – may be helping, this rebound in growth also reflects fundamental economic strengths. The UK has a flexible labour market, an attractive climate for international investment, and competitive strengths in a range of industries, especially in the services sector.
Second, a stronger pound helps to hold down import prices and ease the “cost of living squeeze” which has been a problem for consumers recently. This squeeze was greatly aggravated by the fall in sterling during the financial crisis, which contributed to the above-target inflation we have experienced for most of the time since 2007. A stronger pound and a period of below-target inflation should provide welcome relief for consumers.
Third, the threat of a stronger pound to manufacturers and exporters is greatly exaggerated. Within our largest export market, the European Union, a sterling-euro rate of just over €1.20 is still very favourable to UK manufacturers and compares with an average of €1.38 since the euro was launched in 1999. In China, sterling is still about 30 per cent more competitive against the yuan than it was before the crisis. And against the US dollar, the current value of around $1.68 is close to the historical average since 1980.
UK manufacturing is now heavily concentrated in high-technology sectors which sell on the basis of quality, innovation and brand reputation. Our exports are not particularly price-sensitive, and only if sterling rises much higher could competitiveness be threatened. It is a similar story in the services sector, where the UK is the second biggest exporter in the world behind the US. Our services exports – in areas like financial services, business services, design, creative industries, travel, tourism and media – depend on our professionalism, reliability, and quality of service, rather than an artificial boost from a low pound.
In the UK, we need to stop looking to currency devaluation as the solution to our economic ills. The biggest fall in the pound in modern times took place between the mid-60s and mid-70s. That ushered in one of the worst periods of UK economic performance and it took our economy about two decades to recover from the associated inflation and economic turmoil.
Letting the currency fall may be a temporary stopgap in difficult times. But it cannot create sustained economic success. Indeed, the most successful economy in Europe – Germany – benefited from learning to live with the discipline of a strong currency in the 1970s, when the UK was unsuccessfully trying to devalue and inflate its way out of serious economic problems.
We should learn to live with a stronger pound. It is a sign of economic success, not failure. And sterling could well appreciate further as our recovery develops.
Andrew Sentance is senior economic adviser to PwC, a former member of the Bank of England Monetary Policy Committee, and author of Rediscovering growth: After the crisis (London Publishing Partnership).