Double dip or debt crisis for the UK? Sterling heads lower

February 22, 2010

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-Jane Foley is research director at Forex.com. The opinions expressed are her own.-

The UK may have clawed its way out of technical recession, but over the course of last week data releases highlighted a sharp drop in retail sales and a surge in the claimant count, a spike higher in the inflation rate and record public sector borrowing.

Poor weather and a hike in VAT may have contributed to the poor performance of the retail sector in January.  Even so, with the labour market taking a turn for the worse perhaps it would be optimistic to assume that the consumer sector will remain anything but weak going into the spring.

These data force the question of how sustainable the UK economy recovery will be in 2010 if fiscal support is rapidly withdrawn.  This debate is already intensifying ahead of the spring general election.

From a policy perspective there may exist a fine line between the right amount of fiscal austerity and positive growth that would bolster investor confidence and the pound but given the risks on either side of this could swing as far as a debt crisis (if no austerity is introduced) and a double dip recession (if too much austerity was seen), in all likelihood sterling buyers vs the U.S. dollar will remains scare into the spring and most likely beyond.

The February CBI industrial trends survey provided one of the first pieces of evidence that the weaker pound was having an impact on lifting UK exports.  Official data are yet to show any convincing evidence that the external sector has benefitted even though the sterling effective exchange rate  has recovered only a modest amount of the drastic 30 percent decline recorded between mid-2007 and late 2008.

It may be disappointing that the benefits of a weaker pound have been so long in coming, but with the UK budget deficit/GDP ratio this year set to potentially outstrip that of Greece this year, a flexible exchange rate is likely to prove to be an invaluable support to the UK economy and one that the Greek government may come to envy.

In order to increase its competitiveness the Greek government faces having to slash the number of public sector workers and/or their wage and pension entitlements to restore its budget to an acceptable equilibrium; a feat which it could fail.  There is absolutely no doubt that the next couple of years are likely to be tough going for the UK too but blow to the UK economy should be lessened by the competitive advantage that should be offered by a weakened pound.

There is the risk that sterling weakness may increase inflationary pressures in the UK.  Theoretically this could lead to the Bank of England pushing short-term rates higher sooner rather than later which would hamper growth.  There is no strong correlation between the UK’s effective exchange rate and the CPI although the spike in UK CPI into Q3 2009 was probably fuelled by the weakness in the pound particularly via its impact on oil imports.

That said the Bank maintains that CPI will fall below its 2.0 percent y/y inflation target by the end of its forecast period with high levels of unemployment and excess capacity set to continue bearing down on prices.  If the Bank’s inflation outlook proves to be correct then the boost to the economy provided by the weak pound should more than vindicate the UK’s decision to remain outside of the EMU.  

There are currently no guarantees that Greece will not succumb to the draw of a flexible exchange rate as a consequence of its current fiscal crisis.

Comments

To mention the Uk fiscal state in the same Media as Greece never mind the same article is an insult to the intelligence of your readers, though actually.

I and unsurprisingly 50 or 60 of the top NON Financially motivated economists are increasingly concrned at the publication of ludicrous mistatements of the UK fiscal position.

The posturings of the PAID FOR RENT BOYS of the financial world; otherwise known as Ratings Agencies, are treated with “Tablets of Stone” respect when their complete and transparent criminally fraudulent activites should have dozens of them in gaol.

Mr Soros does what he always has and talked of a Sterling Crisiis last week and it was entertaining to watch his positions unwind (use the 3 minute timer to spot him) and NOW he has decided the Euro is dead.

If it wer’nt so very serious for many lives I really wqould enjoy laughing at the innumerate posturings and dissemblements of the financial media.

Guesses, Lies and “Statistics” and of these three PLUCKED statistics are the greatest evil.

Posted by Paul Arkle | Report as abusive
 

Quite right, one of the few things UK Govt has got right last few years is not joining the Euro. Otherwise would be in the PIIGS camp. Pound going down painful for some (holiday makers, importers) but good for economy in many ways- and indeed Euro may still break up due to pressure from Greece et al.

It is unfortunate Govt also got a huge budget deficit BEFORE the crisis by wasting loads of money for little result, despite counting on tens of billions of excess revenue from property and financial markets. That means the “stimulus” has actually been negligeable and in fact has now been reversed (taking VAT going back up plus the rises in NICS and Income Tax from April, plus cuts in investment this year, there is now NEGATIVE stimulus)- and still the budget deficit worse than Greece…

IMF calling…

Posted by JoeF | Report as abusive
 

I never give any credence to economist`s predictions or prognostications, they are inevariably flawed, ditto most government issued data, I mean how can anyone besides those that originate it take this stuff seriously?
Most ecomomists, with some minor exceptions, along with their politico bretheren, never even saw this mess coming, and further continued in denial when it finally hit home, and that despite being given a multitude of warnings including a ridiculously distorted yield curve, sky-rocketing asset valuations and wafer thin credit spreads.
Price is the determining factor in any market, and that screams at me to short Cable on every single retrace for the forseeable future.

Posted by georgiesfriend | Report as abusive
 

JoeF

The size of the laughable Greek 50/50 economy (50% black, 50% grey) and the massive underecording of income as well as endemic corruption mean it can be frogotten, it is just a boogie man to move the markets.

Geprgiesfriend

How do you match up the fact that the dollar is on its way to being a fairytale fiat with the fact that the world still runs to it when the skids go?

The pounds basics over a 20 year period are so superior to the Eurozone that the Eorpo should be trading at 72 max

Posted by Paul Arkle | Report as abusive
 

JoeF
The dollar is quite simply the best of the worst, nothing more nothing less, you only have to look at Japanese Yen and the crowd assumption of it also being a “safe haven” currency to witness the blind faith principle at work.
Post Bretton-Woods all non-convertible fiats will inevitably follow the same path as their predecessors, which is into oblivion, it`s unfortunately just the nature of the beast.
Data extrapolations are meaningless, we live in the here and now, as before, price and price alone is the determining factor, all else being relegated to a mere roll of the dice.

Posted by georgiesfriend | Report as abusive
 

Mr Arkle,
The dollar is quite simply the best of the worst, nothing more nothing less, you only have to look at Japanese Yen and the crowd assumption of it also being a “safe haven” currency to witness the blind faith principle at work.
Post Bretton-Woods all non-convertible fiats will inevitably follow the same path as their predecessors, which is into oblivion, it`s unfortunately just the nature of the beast.
Data extrapolations are meaningless, we live in the here and now, as before, price and price alone is the determining factor, all else being relegated to a mere roll of the dice.

Posted by georgiesfriend | Report as abusive
 

The collapse of the pound surely demonstrates more than anything just how inept this government is. Many people and organisations rely on the pound maintaining a reasonable value but a 25-30 pct devaluation puts it in a league with banana state currencies. Almost a pity we’re NOT in the euro. Then the government would have to do what is necessary to cut spending and do it now.

Posted by R Thomson | Report as abusive
 
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