My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
Official figures a few days ago for industrial production in Britain produced a surprise. And, for once, it was not a pleasant one. Overall industrial output fell by 0.7% between April and May and within that manufacturing recorded a hefty 1.3% drop.
It was not the only disappointment. Britain’s trade deficit widened from £2.1bn in April to £2.4bn in May on the back of a meagre £0.1bn monthly rise in exports, more than offset by a bigger rise in imports. In the latest three months exports of goods have risen by just 0.1% to £72.6bn, while imports are up 0.5% to £98.9bn.
The industrial figures appear to be an aberration and are at odds with much stronger survey evidence. Manufacturing output in the latest three months was up by 1.1% on the previous three and, this – annual growth of around 4% - is a better guide to what remains a pretty robust industrial recovery.
But the trade figures tell a familiar and more believable story, which is that the great export revival that was going to be an important driver of growth and rebalance the economy, is still eluding us. Total exports in the latest three months in cash terms were 3.6% down on a year earlier. The volume of goods exports was 2% down. It is a strange kind of revival when exports are falling.
The question is whether this is due to the strength of the pound. Sterling Is flavour of the month among currency traders, At $1.71 it is more than 20 cents up on where it was a year ago, and at more than €1.25, it has gained roughly 10 euro cents.
Why is the pound so strong, will it last, and is it the thing holding back our exporters? Simon Derrick, BNY Mellon’s currency strategist, and “a big fan of sterling” says that there is a simple interest-rate story to tell about the pound’s strength.
The Bank of England, while it left interest rates unchanged again last week, is paving the way for the start of a series of hikes, beginning in the next few months. The European Central Bank, in contrast, is still cutting rates – though it has probably now cut them to rock bottom – and is contemplating other ways of relaxing monetary policy.
Reading what America’s Federal Reserve plans to do under its chairman Janet Yellen is far from easy, but two things should be remembered about the Fed. The first is that, while the Bank has not done any quantitative easing (QE) since July 2012, the Fed is still doing it. Though it is tapering its QE asset purchases, it will not stop them until later this year, probably October. The second is that it will not raise rates before the Bank.
Britain’s economy is surprising with its strength and the Bank has suddenly become the muscle man among the seven-stone weaklings. That’s exaggerating it but, when other central banks are bending over backwards to be dovish, even a sparrow can look like a hawk.
CrossBorder Capital, which monitors liquidity flows between different economies, offers another reason for sterling’s strength. Mike Howell, its chief executive, says the interest-rate explanation is important but so too are private sector cash flows, which have rebounded. “British firms are generating sizeable cash flows and this is providing major support to the currency because it signals a robust domestic economy and a strong rebound in corporate profitability,” he notes.
Will it last? In time the Fed will move from relaxing monetary policy to hiking rates, though that is unlikely to be for several months after the Bank has begun to raise rates. Higher interest rates in Europe are a very long way away.
The biggest threat to the pound may be political rather than economic. Derrick notes that sterling’s volatility is unusually low given that we are into the 12-month run-in to the election, normally a period when markets start to factor in some political risk.
He thinks there is not much danger to the pound from September’s Scottish independence referendum, given the state of the polls, but that there is from next May’s general election. For this and other reasons, the pound is unlikely to repeat its rise of the past 12 months. Against the dollar, the story of sterling’s climb may be coming to an end, though it probably has further to rise against the euro.
Is the pound harming industry and exports? We should put its recent rise in perspective. What is the current sterling-dollar rate? $1.71. What is its average for the past 10 years? Also $1.71. For the euro the figures are €1.26 and €1.28 respectively. Before the pound began its slide in 2007, it traded at $2.11 and a fraction under €1.50. Exporters are still benefiting from a significantly lower pound than in the past.
Vince Cable, the business secretary, put it well in a speech to the Social Market Foundation last week. While he acknowledged industry’s concerns about the strength of sterling, he also noted that there was evidence that Britain’s exports were less price-sensitive than in the past and that “there has been a weaker connection between sterling’s crisis-driven depreciation and the strength of UK exports than we might have expected and hoped for”.
Exports depend on whether markets are growing or stagnant and having the right products, services and trade support. They depend on quality, reliability and timely delivery and, as Cable pointed out, British industry raising its productivity game.
We should not blame the pound, which is not in the grand scheme of things particularly strong, for a disappointing export performance.