Sunday, September 07, 2008
A sterling pounding but not a bloodbath
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

floating pound.jpg

Friendless, lonely, unloved. No, not the opening line of my misery memoirs but poor old sterling, which is looking sicklier than an old green pound note.

Since the credit crunch broke just over a year ago sterling has been one of the casualties. Its problems were disguised by the dollar being even sicker, so as recently as July you could still get two dollars to the pound, well above its "fair value" of closer to $1.60.

But the dollar has recovered amid rising optimism about the American economy. The tide has gone out on sterling and, to paraphrase leading investor Warren Buffett, it does not appear to have been wearing any bathing trunks and has dropped below $1.80.

Is this a good old-fashioned sterling crisis, the first under this Labour administration? If so, Gordon Brown's government will be belatedly following the pattern established by all its Labour predecessors.

The Tories have had fewer, though they can claim a couple of corkers, both of which involved Europe the short-lived flirtation with the European currency "snake" in 1972 and the ERM (exchange rate mechanism) debacle of 1992.

This time, the pound has lost more than 10% against the dollar in a month, while its average value has fallen 16% since August last year. If this is new Labour's sterling crisis what will be the consequences?

Since autumn 1996 until last summer sterling was strong and stable. Early last year its average value was its strongest since the 1980s and it stood at a 26-year high against the dollar. Sterling benefited from big flows across the exchanges, into City markets or as a result of the takeover of British firms by foreign competitors.

What changed? The flows were sharply reduced. More importantly, Northern Rock, and queues of anxious depositors, shattered the impression of a well-regulated economy and banking system. International investors who subscribe to the Blink theory first impressions count took a look at the run on the Rock and took flight.

The Rock was the catalyst for a rerating, downwards, of sterling. It exposed shortcomings in the Bank of England, Financial Services Authority and Treasury. It coincided with a big increase in political risk in Britain, as viewed by the markets.

When Tony Blair was in charge, investors saw Britain as politically stable, boringly so. The decade-long saga of Brown versus Blair was entertaining but irrelevant.

Under Brown, in contrast, dealers have perceived a government persistently in trouble, particularly since "the election that never was" last autumn. When the government is in trouble, the currency is usually not too far behind.

Why, apart from the dollar, has the pound taken such a dive in the past few weeks? Bizarrely, to me at least, currency dealers are still taking at face value Alistair Darling's comments last weekend that the economic circumstances faced by Britain are the worst for 60 years.

Even after a week of nervous broadcast interviews from the chancellor meant to clarify things, the perception remains that he must know something we do not and, in an unguarded moment on his remote Scottish hideaway, blurted it out.

That was not the case. I have found myself raging at the television at his inability to get over the message that, first, global challenges may be the toughest for 60 years but, second and more importantly, Britain is not facing the biggest downturn for 60 years, and nothing comparable with the recessions of the 1970s, 1980s or early 1990s.

The chancellor has found it hard to get that over, maintaining uncertainty. Mud sticks, particularly mud thrown at a currency by the man responsible for its stability.

Adding to sterling's woes has been deepening gloom over the economy, including a prediction from the Paris-based Organisation for Economic Co-operation and Development (OECD) that Britain will be the only G7 economy to experience recession this year.

Let's take a closer look at that forecast. The OECD deals in annualised growth rates and says the UK economy will decline at an annualised rate of 0.3% in this quarter and 0.4% in the fourth. The way we do the numbers actual rather than annualised changes it predicts a decline of 0.075% in the third quarter and 0.1% in the fourth. My colleague Irwin Stelzer says economists use decimal points to show they have a sense of humour, in which case the OECD is having a laugh. And there's more. The OECD got to its numbers by revising its model to give house prices a bigger role.

Moreover, we are doing better than Germany. Its economy declined by an annualised 2% in the second quarter, the OECD says, and is predicted to be flat in the third. Over the two quarters, the German economy will have declined more than the Paris body expects for Britain. The same is true for France and Italy.

Britain's growth in 2008 is projected at 1.2%, stronger than France, Italy and Canada and on a par with Japan. Britain faces challenges, and avoiding some quarters of declining gross domestic product presents an enormous challenge. But the label "hardest-hit in the G7" simply does not fit. The economics points to a further fall for sterling against the dollar but suggest its drop against the euro has been overdone.

Of course there is gloom. Halifax says house prices fell 1.8% last month and more than 12% on a year ago. If you believe those numbers it is easy to be pessimistic. But the broader evidence on the economy in recent days has been mildly encouraging. All three purchasing managers' surveys for manufacturing, construction and services were up in August, showing that so far the economy is not falling off a cliff. Those "weakest since 1966" August car sales should not trouble us much. Until the change in the number-plate system a few years ago, August was the busiest month of the year. Now it is one of the quietest.

David Miles, Morgan Stanley's chief UK economist, in a report entitled Pessimism Becomes Excessive, has it about right. Britain is due for a period of "negligible growth, rather than protracted falls in output".

For the dealing-room boys in white socks the pound has been a screaming sell. But these things pass. In the meantime, if it does not get out of hand, sterling's fall will help both in rebalancing the UK economy away from consumer spending and getting us through these difficult global challenges. And it won't prevent the next move in interest rates from being down.

PS: I will report back on bizarre credit-crunch headlines, and a new strand imaginative use of the crunch in advertising soon. Keep them coming. Meanwhile, another thought.

When Gordon Brown was chancellor, he complained of pressure from Downing Street to do more than was prudent. He claimed he won those battles. Others, looking at the public finances, would disagree. Now the boot is on the other foot. Maurice Fitzpatrick of Grant Thornton asks whether the unplanned tax give-aways, nearly 4 billion since the budget, amount to a "scorched earth" policy; leaving things in a state that presents huge problems for the next government.

Treasury officials are doing their best to limit the damage. The stamp-duty "giveaway" was probably the smallest they could get away with. They know they will be around to pick up the pieces.

From The Sunday Times, September 7 2008