My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
They are the two sides of the same pound coin. Sterling’s sharp post-referendum fall has pushed inflation above the 2% target and is squeezing household incomes but it is also providing a boon for exporters.
Ben Broadbent, one of the Bank of England’s deputy governors, pointed out in a speech on Thursday that the weaker pound boosted export prices, in sterling terms, by 12% during the course of last year.
Though the pound has perked up a little in recent days that effects, which as Broadbent says “will have significantly boosted exporters’ profitability” is still coming through.
No part of the economy is more exposed to these conflicting effects than manufacturing. For manufacturers, 2.3% inflation – the latest reading for the consumer prices index – is child’s play. They have seen a 19.1% rise in raw material and fuel costs over the past year.
They are also, it is clear, benefiting from the upturn in exports as a result of the weak pound. The latest CBI industrial trends survey, published last week, showed export order books at their healthiest since December 2013, with total order books close to a two-year high and output expectations buoyant.
Surveys by the EEF, the engineering employers’ federation, which represents manufacturers, have shown a similar strong picture, as have recent official figures. The surveys show that industry’s optimism is tempered by its concern over sharply rising costs, but that there is optimism nonetheless.
So how will these two factors balance out? Is it time to celebrate the early stages of a sustained revival in manufacturing, one that we have been waiting for a long time, or will this be another false dawn? Some context is useful here.
Though the latest official figures showed a dip in manufacturing output in the early part of the year, they also recorded a rise of 2.1% in the November 2016-January 2017 period. That, incidentally, was the best three-monthly performance since May 2010.
The comparison is a reminder that there have been high hopes for manufacturing before in the post-crisis period. For a while at least, it seemed that industry would be boosted by sterling’s big 2007-9 fall during the crisis and the fact that the service sector, particularly financial services, would be hobbled by a significant post-crisis hangover.
Britain’s manufacturers were, however, quickly hit by a combination of the eurozone crisis and weak domestic demand, and had a disappointing 2-3 years. Almost as soon as George Osborne had uttered the words “march of the makers”, the sector began to struggle.
2014 was a good year for the economy and for manufacturing, with factory output up by 2.9%. The following two years were, however, disappointing, however, with output slipping by 0.2% in 2015 and growing by just 0.8% last year.
The result of all this is that, even after its recent revival, manufacturing has yet to get back to where it was before the crisis; even after its recent revival its output is 3.3% lower than the pre-crisis peak in January-March 2008. The service sector was not so hobbled after all; its output is almost 14% up on the pre-crisis peak.
What about now? In the eye of the sterling storm, it is important to remember that the same factor affects the various parts of manufacturing in different ways. George Nikolaidis, a senior economist at the EEF, points out that for high-value manufacturers, including aerospace, capital equipment and automotive, the net effect of a lower pound is positive. For these sectors exports are receiving a boost, and that more than outweighs the impact on costs. Other “commodity” parts of manufacturing, including basic metals and basic pharmaceuticals, are also receiving a leg-up.
We should never forget, however, that many manufacturers do not export at all, particularly smaller firms, and so for them sterling’s fall simply adds to costs and does not produce any offsetting benefits. Large parts of food and drink manufacturing, textiles and the building supplies sector are in this position.
How will all this balance out? The EEF champions manufacturers but is far from upbeat about prospects for the next couple of years. It expects manufacturing growth of just 1% this year, slowing to a mere 0.1% next. Weaker growth in consumer spending will hurt domestic-facing businesses, while subdued business investment will hold back firms making capital equipment. If the EEF is right, the net effect will be that manufacturing output will still be below pre-crisis levels in two years’ time, so a lost decade for industry.
What of the longer-term? As I have written before, it would be a huge failure of negotiation if Britain and the EU cannot come up with a decent trade deal for goods, and hence manufacturers. The biggest problems are likely to arise for services.
So should manufacturers be investing, at least in those sectors which benefit from sterling’s weakness, or holding back as the EEF and others expect? They face, as Broadbent pointed out, “a somewhat tricky decision”.
Even for those sectors currently benefiting from the weak pound, higher costs will eventually come through to limit any long-term benefits. That has been the story of Britain’s past devaluations. What he describes as a “sweet spot” will not last.
If, on the other hand, the currency markets have got it wrong, the post-Brexit outcome for Britain’s economy in overall terms is better than feared, then one obvious consequence would be that the pound would claw back some, or all, of its losses. The competitive advantage would be more directly lost.
Though some argue that the pound was overvalued before last summer, there is no good evidence of that. Washington’s Peterson Institute, which pioneered the measurement of so-called fundamental equilibrium exchange rates, suggested that the right rate for the pound in April last year was $1.52.
Either way, businesses may want to wait and see. That leaves, Broadbent says, an argument for investments in manufacturing with “short-term payoffs”. Some exist. Mostly, though, manufacturers like to plan and build for the longer-term. The double-edged coin that is represented by sterling’s fall makes it harder for them to do so.