WITH the Eurozone back in crisis, it is tempting to assume that Britain will be fine, that we don’t share the problems plaguing much of the continent. Such complacency would be a mistake. As an intriguing note from Credit Agricole points out, there are growing signs that investors are losing confidence in sterling’s status as a semi-safe haven, to use the somewhat bizarre term favoured by many market participants.
After peaking at £38bn in November 2011, Bank of England data shows that foreign investor demand for gilts has slumped, registering a £5bn outflow in the three months to June 2012, according to the French bank. Foreign capital inflows from abroad were one of the drivers of the pound’s relative strength during the crisis; if this reverses, perhaps because of growing fears about the budget deficit, George Osborne’s claim to have tamed the financial markets will look increasingly hollow.
In fact, in what could be the first signs of a shift in sentiment, the effect has already started to show on the foreign exchange markets, as some of those seeking to buy currencies to travel abroad this summer will have noticed. To see the significance of this change, it is worth taking a look at recent history.
Sterling’s broad nominal effective exchange rate had spectacularly outperformed both the euro and dollar since early 2009, following a collapse in the pound’s value in the early stages of the crisis and during its peak. The pound’s 7.5 per cent gain over the past 12 months is a key reason why it is up by more than 10 per cent over the past three years. Sterling/euro is up close to 13 per cent in the past 12 months and by more than 20 per cent in the past three years; the pound has also done well against the dollar, Swiss franc and Norwegian kroner.
Yet more recently the dollar has recovered, with the pound falling over three per cent against the greenback in the past 12 months. The pound has also dipped against the yen, Canadian dollar and Australian dollar over the past three months, helping exporters to those markets. The Credit Agricole research shows that sterling has underperformed against other developed country currencies recently.
So what are we to make of all of this? It does seem that some investors have started to see through Osborne’s propaganda. The economy has ground to a halt, at least if the official statistics are to be believed; what is certainly unquestionable is that the public finances are deteriorating again. Most depressingly, income tax receipts are falling; declining pay and bonuses in the City are part of that story, something that banker-bashers would do well to remember. Another lesson is that those who are relaxed about the budget deficit and actually want to borrow even more (supposedly to stimulate demand) need to think again. The markets are much more fixated on the deficit than most commentators realise. They have begun to notice that things are not proceeding according to plan, and are starting to vote with their feet.
Who can blame them? Last Friday’s budget deficit figures were woeful. Borrowing is on course to overshoot the official full-year forecasts by a long way – on current trends, by £20bn, according to Capital Economics. Osborne’s saving grace, as ever, will be the Eurozone’s even worse performance: it is clear that Spain will need a huge bailout and that Greek debt will require another restructuring. The UK, which will simply continue to monetise its debt, will never look as risky in comparison. But perceptions of the UK are clearly shifting, and not for the better.