Unit 4: Impact of a strong Pound

Really useful article on a topic that comes up lots in Unit 4. It has been an issue for over a year now, so could be the focus of a case study questions.

It would be great to see you in school to discuss this.

Last autumn all the talk was of the impact of a plunging sterling exchange rate and the UK’s struggle to find new export markets. 

According to most observers it was time to ‘rebalance’ the economy towards a more export-lead model of growth. George Osborne, the chancellor of the exchequer, talked of “a Britain carried aloft by the march of the makers”. The plan was for a revival in manufacturing and exports, driven, at least in part, by a weaker pound. Sterling had fallen by 30% during the financial crisis, but since early 2013 the pound has climbed back, appreciating by 10% in trade-weighted terms.

What impact might this have?

The Economist (source of the graph below) takes up the story, arguing that the rise in sterling is partly good news: it reflects the strength of GDP growth in Britain, which is now the strongest in the G8, as well as the expectation that interest rates will rise sooner as a result. Sterling looks like a relatively safe and stable storehouse for foreign cash as emerging markets wobble.

It is also good news for households—in the short term, at least. Following the 2007-08 exchange-rate depreciation, higher import prices pushed up Britain’s inflation rate, which peaked at 5.2% in 2011 (about a quarter of the value of consumer goods and services originates abroad). With sterling now on the up, inflation has declined to 1.6% and may fall further. Households’ increasing spending power ought to boost both consumption and imports.

But a stronger pound increases the costs of British exporters relative to those of their foreign competitors. At first glance, exporters seemed to gain little from sterling’s big depreciation during the crisis: demand for exports and imports have proven to be relatively price inelastic.

But, according to the article, the weakening pound probably prevented an even more disastrous outcome. After all, the financial crisis dealt a colossal blow to the financial-services sector, one of Britain’s biggest export industries. Without the depreciation, Britain’s exporters might have fared much worse. Now that sterling is rising again,British exporters’ share of world trade may well fall even faster.

The current-account deficit—already 5.4% of GDP—is worrying. Higher imports and lower exports will make it worse. It will also become harder to fund the deficit in the practised British manner: by selling houses and firms to foreigners.

The authors conclude that all this will mean that Britain borrows more from the rest of the world. That is not sustainable indefinitely. Large and persistent current-account deficits, financed by debt, have a habit of spawning violent financial crises. To avoid that fate, Britain must rebalance.