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Sterling's long decline comes to an end

Allister Heath
IT may seem strange given the dire state of Britain&rsquo;s public finances but sterling is starting to regain some of its strength, especially against the dollar. Yesterday the pound rose above $1.60 for the first time in seven months, boosted by better services sector sentiment and mortgage approvals. Sterling is now trading well above its lows of around $1.38 at the turn of the year &ndash; though it remains way below the unsustainable peak of&nbsp;&nbsp; $2.10 or so&nbsp; reached in late 2007. When measured against all of the currencies of Britain&rsquo;s main trading partners, the pound&rsquo;s decline has been cut to about 25 per cent from its peak.<br /><br />There is a simple explanation for this admittedly only very partial recovery. Traders had over-estimated just how badly the UK economy would fare compared to other countries. They were right that it would do appallingly; but they were wrong to think that Britain would perform much worse than other large states like the US or Japan. The surprise has been that countries such as Germany, which didn&rsquo;t suffer from a house price bubble and don&rsquo;t especially rely on financial services, are suffering an equally disastrous recession as a result of the&nbsp; collapse in trade. This is beginning to help the pound against the euro.<br /><br />And while there are real worries that uncontrolled quantitative easing will debase the currency, this has yet to happen &ndash; and in any case, America and other economies are now pursuing similar policies. It is also clear that the US will suffer from a budget deficit in the years ahead of a similar order of magnitude to Britain&rsquo;s; again, the factors underpinning sterling&rsquo;s bounce have nothing to do with actual strength here in the UK but rather the realisation that other economies are equally weak.<br /><br />So much for sterling&rsquo;s partial recovery. But even at these slightly more elevated levels, the pound is beginning to have a positive effect on UK trade. As Vicky redwood of Capital Economics points out, our still hyper-competitive exchange rate is the main reason UK export orders have risen significantly more than those in the US or Eurozone. Only in the UK, for example, is the balance of new export orders even close to the 50 level that separates expansion from contraction. And while the collapse in world trade is finally beginning to abate, Britain is doing better than other countries. World trade volumes fell by six per cent in the fourth quarter, while exports of UK goods and services fell by a smaller four per cent, despite the collapse in our sales of financial services, thanks to the weaker pound. Imports have fallen at a much faster rate than exports, as UK-based buyers have been discouraged by higher prices from purchasing foreign products; the result has been a 5 percentage point drop in imports&rsquo; share of total domestic expenditure. The long wished-for rebalancing of UK trade is finally taking place, helping to cut the balance of payment&rsquo;s long-standing dependence on short-term capital inflows. Needless to say, exporters in the City and factories across the country won&rsquo;t be welcoming the gradual recovery in sterling (though anybody planning a foreign holiday will be). They should all relax: sterling undershot widely at the height of the credit crunch, but that followed an equally extreme over-shooting in 2006-07, a time when the world had fallen in love with the British &ndash; and especially the London &ndash; economy. It all evens out in the end.<br /><br />allister.heath@cityam.com