Sterling’s slump is costing us all dear
WELCOME to price hike Britain. Wherever one looks, consumer goods and food are becoming dearer. Energy prices are rocketing. One fundamental reason for these increases is the collapse in the value of sterling since the recession, a development which has been insufficiently well understood by the UK’s political establishment. Sterling’s slump is a dramatic reversal of the trend between 1997 and 2007, during which a strong pound (combined with the rise of China) slashed prices of imported goods, delivering a windfall to consumers. The trade-off was two-fold: the decline in UK manufacturing accelerated; and the Bank of England was lulled into a false sense of complacency, mistaking low overall price rises for a successful monetary policy (in fact, excessive liquidity was pouring into asset markets such as housing, fuelling bubbles).
The declines in the prices of imported goods followed the surge in sterling with a lag of several years. The pound rose 31 per cent on a trade-weighted basis and 26 per cent against the euro from December 1995 to December 2001. That period coincided with a (unfortunately misplaced) greater global confidence in the UK’s prospects and an increased trust in its inflation-fighting credibility. Slowly but surely, the strong pound fed through to lower UK consumer goods prices: excluding food, drink, tobacco and energy, these fell by 18.6 per cent from January 1997 to January 2007, by far the biggest drop in the EU. During the same period, prices rose by 8 per cent in the Eurozone. After years of being expensive, the UK started to look better value, with prices in many global cities dearer for the first time in ages than prices in London, and many Europeans travelling here to enjoy bargains. The 27 per cent drop in the UK’s relative price level eventually fully mirrored the currency shift.
A similar process is now happening in reverse, as an excellent research note from Michael Saunders of Citigroup explains. Since January 2007, sterling is down 25 per cent in trade-weighted terms and by 32 per cent against the euro, a huge drop. This has made UK exports more competitive, foreign holidays more expensive and is now starting to feed into the price of imported goods. Since January 2009, prices are up by 6.8 per cent in the UK, more than twice the 3.1 per cent suffered by the Eurozone. Price rises have only just begun, assuming that the pound remains so weak. Slowly but surely, the era of bargain-basement Britain will come to an end and prices in supermarkets – even those of Chinese goods – will end up costing as much as they do elsewhere.
This effect will be much more powerful and have a dramatically larger impact on the vast majority of the population than Chancellor George Osborne’s cuts. Crucially, the argument that UK monetary policy has no bearing on the price of imported goods is a nonsense, as the figures above demonstrate. Britain’s decision to keep interest rates at an ultra-low level almost permanently has driven sterling down and is thus fuelling all of this. The Bank appears to have decided to tolerate higher goods prices rather than hiking rates to keep rises in the overall price level under control by depressing total demand, which is what its mandate suggests it should do. Instead, it wants to boost exports and ignore (supposedly) short-term inflation. If that is indeed its new strategy, we should at least be told.
allister.heath@cityam.com
Follow me on Twitter: @allisterheath