THE MEDIA has moved on from the Conservative leadership election and Royal funeral and has now started to worry about the falling pound – but should we?
The Pound is low relative to the US dollar, but so are most currencies at the moment, except interestingly for the Russian Rouble. Although before you get too excited the rouble has only gone from 0.014US a year ago to 0.017US now, it was as high as 0.042 in 2008 and as low as 0.0076 in March of this year.
The Dollar is high because the US Federal Reserve started to increase US rates in June in large 75 basis point moves. This seemed to catch most other Central Banks off guard, or on holiday. The Bank of England did increase its base rate in June but only by 25 basis points. The Bank of England doesn’t meet in July so we had to wait until August for another rise, this time of 50 basis points but by this time the US had increased their rates by another 75 basis points and was declaring that they would be at 3% before the end of the year. It is this differential in Central Bank base rates, UK at 1.75% versus US at 2.5%, that has caused the divergence between the US currency and the UK’s. In June both the UK’s and the US’s base rates were 1%. The US Federal Reserve is expected to increase US base rates again today, many economists are expecting another 75 basis point move, pushing US rates to 3.25%.
The US is increasing its rates to help combat inflation by taking money out of the market to depress consumer spending. In theory, people with variable mortgages or credit card debits as well as business with working capital loans, all have to pay more money in interest payments and so have less money to spend on consumer goods while a higher rate encourages more saving.
The US has massively increased its money supply during covid and afterwards with Biden’s ironically named Inflation Reduction Act and his student loan payments – so increasing interest rates probably won’t reduce US inflation although its imports will be much cheaper. The US is the world’s largest importer of almost everything.
Luckily for Biden, the US is still the world’s reserve currency, so the US can get away with printing trillions of dollars and borrowing even more without international investors fleeing the currency. After all, what is the alternative investment? Gold pays no interest, and 2.5% to 3.25% is better than nothing, especially if your capital is increasing in value compared to your home currency.
The UK is not in the same boat. Nor is the eurozone for that matter. Both must balance the importance of the currency along with consumers’ and businesses’ ability to pay higher interest rates and unlike the US – massively higher energy bills.
If the UK had increased its interest rates during the summer in lockstep with the US, our currency would be stronger, but a sudden large increase in rates (business loans are mostly variable rates priced at a premium over the base rate), together with our massive energy bills, could have driven small businesses into receivership or caused them to default on their loans, which would fall back on the banks and then onto the Bank of England.
Also, a large increase in UK rates probably wouldn’t have reduced consumer spending. According to the FCA, the number of UK mortgages has fallen from over 15 million in 2007 to only 13.4 million at the end of 2021. While the proportion of new mortgages with a fixed interest rate has increased from just under 65% in 2007 to 94% at the end of 2021. Consumer spending would be effected by higher credit card rates but higher prices seem to have been just as effective: Retail sales fell by 1.6% in August, with non-food sales volume down by 1.9% and department stores sales volumes down by 2.7%.
We should look at a relatively lower pound as a gift from the US
Many net exporting countries have tried to keep their currency low relative to their major export markets. China is a master of this, as is Turkey. This used to be called the Beggar thy neighbour policy as a relatively low currency made imports more expensive compared to local products and made exports cheaper in other markets. Lowering your currency on purpose was generally viewed as poor form in the 1980s but if the US is gifting the UK with a relatively cheaper currency – why should we complain? The US is already our largest export market, but if a lower pound increases exports of UK goods to the US, then we should grab this opportunity with both hands.
Many economists and especially the pro-Brexit businessman John Mills, have been trying to convince anyone who would listen that the UK pound was too high for manufacturing to survive in the UK and that a lower pound would help the UK to redevelop its industrial base. But even our service industries such as fund management, legal, consulting and accounting services have their costs in pounds so will become relatively cheaper for US customers. A boost to UK exports from a lower pound might save us from a recession.
And although the UK is presently a net importer, in some cases this is caused by our strong currency. It is often cheaper to import goods than to make them ourselves purely because of the currency differential. However, to transition from net importer to net exporter we would have to find products where we can compete. This will not be against very low wage countries or countries with relaxed employment regulation. The UK’s best bet would be to use its intellectual advantage and concentrate on new technology and highly technical manufacturing industries that won’t be easily imitated by lower cost countries.
But what about our imports?
Many of the countries that supply the UK imports also have currencies falling relative to the dollar. China is our biggest import supplier, then Germany, then the US, Netherlands, and Norway.
The Chinese yuan is at its lowest point against the US dollar since July 2020, but it has strengthened again the Pound and is now just under 8 Yuan to the pound having been just under 9 yuan a year ago. A strong Yuan will make Chinese imports more expensive and help UK industries reshore their production. This will help the UK diversify its suppliers. If Covid taught us anything, it should be not to be dependent on one supplier. Security of supply requires multiple sources.
Other Asia currencies – the Japanese Yen and the South Korean Won have been in a similar trading range against the pound for the last year. The Indian Rupee is off its 2020 lows but still below its 2019 level. These countries could possibly provide alternatives to Chinese manufacturing. As could Indonesia, Vietnam, Malaysia, and the Philippines.
However, the Euro is at its lowest point against the US dollar since 2002, and at 1.15 to the Pound, is in the middle of its most recent trading range against the GBP, 1.09 to 1.19. So, the cost of our imports from Germany, the Netherlands, Belgium, France, Italy, Spain or Ireland won’t change much. This covers a lot of our food and drink imports as well as many cars, clothes and footwear. If these prices are increasing it would be because of their increased production costs – higher gas or fertilizer prices, not the currency.
But the US is our third largest import supplier, suppling the UK with, in order: machinery and parts; precious metals and stones; mineral fuels and oils; electrical machinery and equipment; precision and optical equipment; aircraft and spacecraft; plastics; wood and charcoal; chemicals etc. these will be more expensive. Although most homogenous commodities are priced in US dollars internationally such as: oil and gas; gold and silver; sugar and coffee; corn and soy; most have seen their prices drop as the US dollar has increased. The international price of commodities is often determined by the willingness to sell of the major exporting countries – generally not the US.
The UK’s biggest source of imported inflation was natural gas but even its price is falling now along with the oil price. West Texas Intermediate (WTI) saw its high point of $122/bl in early June before the first US rate hike, but it is now down to $85. Brent Crude, a heavy crude from the North Sea is also traded in US dollars and has also fallen from $121/bl in early June to $92 dollars now. By the way, contrary to what many pundits say, there is not one oil price, there are many different oils traded, with different characteristics – I am only going to quote two but if you want to know the price of MURBAN Crude or Louisiana Light you can look them up yourself. Similarly, there are several natural gas prices. European TTF Gas is down from a high of Euro 345 per megawatt hour in August to 193 last night, while UK gas is down from £6.43 per Therm in August to £3.15 last night. US Natural Gas is $7.72 per MMBtu. Yes, that means that UK gas is 5 times the price of US gas and EU gas price is almost 8 times the US price.
But it is hard for the British or the Europeans to worry about the price of gas when both have untapped natural gas reserves that they have chosen to leave in the ground – what did they expect would happen to prices when they reduced supply?
With commodity prices falling, the UK is closer to a recession than inflation. It may take a few months for lower input prices to lower consumer prices and employment is a lagging indicator in a recession. So, I am hoping that the Bank of England doesn’t chase US interest rates and that the Moaning Myrtles in the mainstream media stop worrying about the cost of their skiing holiday in Aspen and start to think of the UK economy. A lower pound may be just what we need right now.
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