What if sterling begins to fall?

Press, 2 September 1980, Page 24

What if sterling begins to fall?

By

DAVID BLAKE

of “The Times,” through NZPA

The British Government and the Bank of England have a short and effective way of cutting off discussion about whether the present rate of Sterling is a! bad thing. It is to say that,! even if it is admitted that it is, there is nothing that anyone can do about it. Sterling is high because of North Sea oil and because of confidence about the Government’s policies and it is in any case an inevitable consequence of the domestic policies heeded to beat inflation, they say. I The purpose of this article; is to argue that there is a case for saying that the| strength of the pound is not inevitable and that Sterling might, possibly, come under pressure during the course of the year. If this happens, the Government will no longer be able to hide behind its

present stance. It will have to take a view about wheth-i er it is prepared to accept a fairly sharp fall in Sterling. Let us start with one of the most puzzling features of the present position. All news is good news. If the indicators are genuinely; good, such as the fall in in- 1

tlflation, markets are encourI aging and Sterling goes up. i If the indicators are bad, ■ | like the last set of money supply figures, the market II expects the Government to ,ltry harder in future so, again, Sterling goes up ■.Wage increases are clearly ! still showing no sign of re- : spending to the Govern- ’ ment’s policies. Recently we saw a new acceleration in the annual rate of pay increase, which ; ought, for the rest of the year, to quieten the suggestions that wages are now {under control. Yet Sterling strengthened. I These are short-term phenomena. But there is a . longer term trend to which a number of commentators, including Phillips and Drew ip the City, and Morgan Guaranty in New York, have drawn attention recently. This is the extraordinary-

: rise in the real exchange • rate which has occurred . since 1977. The real effective rate of Sterling is now some ’ 40 per cent above its aver- ; age level in the 1973-74 period. It is likely to move even further out of line over ■the next year. , 1 Nor can even the most op-

| timistic forecasts about the likely development of wages 'in the near future suggest a fall in the real exchange rate or, to put it another way, an improvement of price competitiveness. (The real exchange rate is calculated by looking at how the nominal exchange, rate has moved and adjusting for inflation). It may, if the Government is very lucky, be possible to get wages down to a level where our inflation is no worse than most of our partners’. But it is hard to see any prospect of inflation in Britain actually being lower than it is in, say, Germany. At most a slowdown in wage increases in Britain will prevent a further loss of competitiveness. It could not restore ' the competitiveness which has already been lost. Just how great that loss in competitiveness has been was shown again by Phillips and Drew last week which! pointed out that we have, been losing competitiveness for nine quarters, which' is nine months longer than the longest loss of com-

petitiveness of any other currency. Compared to our “trend competitiveness,’’ our loss is 24 per cent. The yen once lost 18 per cent competitiveness, but no-one I comes near our experience, j At present, import vol- ' umes are greatly depressed jby the impact of recession and the whole of the current (account is benefiting from 'the workings of the “J--curve”. This means that the first impact of a rise in a currency is to improve the trading balance because we charge more for our goods. It is only, later that the volumes of exports and imports respond. But can this go on for ever? At the heart of the strength of Sterling lies a very simple phenomenon. There have been huge inflows of foreign funds attracted by the high interest rates .available in London. Just how great can be seen by looking at the way in which Sterling liabilities to overseas residents have risen from about EOOOM in June last year to about £IO,OOOM in July this year. These liabilities are not Sterling balances in the old sense of reserves held by other countries in Sterling, but they are potentially hot money which might flow out. The precipitate fall in dollar interest rates which provoked the last rise in Sterling seems to have ended. Prime rates are if anything, edging up. The differential; between Sterling and dollar rates seems unlikely to widen again and it. may nar-i

row unless the authorities in London were to choose to raise interest rates again, something they have shown no sign of doing in recent weeks.

In the foreign exchange markets there is widespread speculation of some realignment in the autumn, probably affecting the currencies of the “snake.” Yet why should only those currencies be affected when py all the normal rules of parity determination it is Sterling which should be expected to fall. If the next set of money supply figures are bad, as seems quite probable, will the market shrug them off again? And what will the Government do if the market does react badly to some piece of news? A strict interpretation of its non-interventionist stance would require it to stand aloof and let Sterling fall. Many distinguished sup-, porters of the international monetarist school would approve of that, since it would be getting rid of an artificial overvaluation.

Industry would be profoundly relieved to see some of the pressure eased. And yet, I wonder . . . The high exchange rate is one of the few things working in the Government’s favour at present in the battle against inflation.

Sterling slides have a habit of seeming a good idea at first and getting out of hand, later. It would be interesting to see the Government would look on a fall Yof Sterling with as much equanimity as they have showm in observing its rise. ;-7 ;