Talking down the pound

The Bank of England Governor says he is pleased that sterling's value is falling – but there'll be a price, reports Sean O'Grady

Bad news for Alpine skiers, lovers of fine burgundies and anyone who fancies a shopping trip to New York: the pound is down, it's going lower and its weakness will damage your standard of living. The "staycation", you might say, is here to stay. The good news is that a weak pound ought to help keep you in work, a slightly more weighty consideration. The Bank of England has been busily talking down the pound this week, but that is only part of the story.

Despite a rally earlier this year, sterling's dramatic falls in recent days have reasserted the strong trend visible since the credit crunch broke in 2007 – the long-term decline of the British currency. The pound stands 25 per cent down on where it was two years ago, a scale of depreciation at least comparable to other historic episodes, such as the 1967 devaluation, the crises of 1976 and 1985, and Britain's forced exit from the European Exchange Rate Mechanism (ERM) in 1992. In terms of the "psychological thresholds" that often grab the headlines, the pound seems certain to drop below $1.60, and may edge even closer to parity with the euro, just as it did towards the end of last year.

The timing of the decline has not been coincidental. The UK's reliance on the City and financial services – though often overstated – meant that the collapse in this sector was going to hit its long-term prospects disproportionately hard, and quickly. Three things have been going on here.

First, there seems to have been a permanent reduction in the capacity of the UK's financial sector to create wealth, just as if bombers had suddenly dropped 1,000-tonne bombs on the Square Mile and Canary Wharf. The disappearance of players such as Lehman Brothers represents a loss of competitive advantage, because investment banking was one of the few areas in which Britain led the world. Second, and added to that, is the fact that the crisis has reduced global demand for financial services and products.

Third, is the suspicion that whatever comes out of the panoply of proposals for regulatory reform of the banks, it will not necessarily be good for the City, which thrived for years on a "light touch" from regulators and spectacular, minimally taxed bonuses. Taking fewer risks may well mean seeing smaller returns, fewer jobs in banks and lower pay.

It was these factors that brought Bank of England researchers to warn: "The long-run sustainable real sterling exchange rate, the rate consistent with a balance of UK real aggregate demand and supply and a sustainable external net asset position, may have fallen."

The UK's mountain of public and private debt also overshadows the pound, as does the nagging knowledge that the size of the country's banking sector in relation to her national income is one of the highest in the world. Taken together, the liabilities of Britain's banks amount to something like 450 per cent of her gross domestic product – far higher than in the US (100 per cent) or the rest of Europe (typically 200 per cent or 300 per cent). We may not have to rescue any more banks, but no one can be quite sure. Again, unhelpfully for sterling, is the currency and maturity mismatches between the UK's external assets and liabilities, as if the whole country were a badly exposed bank. Such a context makes for unease among investors and the credit ratings agencies; risk premia are running high.

The recognition among policymakers is that the time has come for the UK to undertake an historic "rebalancing" of its economy – away from borrowing, consuming and making a living from the City and towards a trade balance, higher rates of saving and a switch back to manufacturing and exporting, albeit of the "hi-tech" variety often promoted by the Business Secretary, Lord Mandelson.

The Bank of England Governor, Mervyn King, made a particularly strong intervention last week, saying: "The fall in the exchange rate that we have seen will be helpful, but there is no doubt that we need to see a shift of resources into net exports that compete with imports and help to reduce the trade deficit." His comments immediately pushed sterling lower. The last factor that has spooked the markets is the UK's soaring budget deficit. Recent figures suggest that it may be as high as £225bn this year, approaching 10 times the figure during the boom earlier this decade. In May, Standard & Poor's switched its outlook for the UK from "stable" to "negative", adding that there was a one-in-three chance that our AAA credit rating on sovereign debt may be lost. Subsequent assessments from other agencies have not been so gloomy, but analysts are still edgy about the markets' appetite for gilts, especially when the Bank winds down its quantitative easing programme, spending £175bn on buying gilts.

Usually, British devaluations and depreciations end in tears, or rather inflation: import costs rise, pushing wages and prices higher and squeezing profits. Within a few years, the benefits of depreciation are usually dissipated. Globalisation may have rendered the exchange-rate weapon less potent than before.

But the last time the UK tried this trick it did work – after Black Wednesday in 1992. Then, as now, the recession and the need to rebuild the public finances, and a more flexible labour market, kept inflation down and put the economy back on track for sustainable growth. That British exporters have not yet seen much benefit from the collapse in sterling is because their markets have been depressed, but they are recovering. How might they be doing if a pound was still worth $2?

If all goes well, the next few years could see the UK in growth, albeit more modest than in the boom years, with low inflation and possibly even a trade surplus – a state of affairs for which there are few precedents. Your foreign holiday will cost more but, as the new austerity teaches us, that is how it should be.

Start your day with The Independent, sign up for daily news emails
Arts and Entertainment
Supporting role: at the Supreme Court, Rhodes was accompanied by a famous friend, the actor Benedict Cumberbatch
booksPianist James Rhodes on the extraordinary legal battle to stop the injunction of his memoirs
Arts and Entertainment
Jesuthasan Antonythasan as Dheepan
filmDheepan, film review
Sport
Steven Gerrard scores for Liverpool
sport
News
Tattoo enthusiast Cammy Stewart poses for a portrait during the Great British Tattoo Show
In picturesThe Great British Tattoo Show
News
ebookA unique anthology of reporting and analysis of a crucial period of history
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Guru Careers: Software Developer / C# Developer

£40-50K: Guru Careers: We are seeking an experienced Software / C# Developer w...

Neil Pavier: Management Accountant

£45,000 - £55,000: Neil Pavier: Are you looking for your next opportunity for ...

Sheridan Maine: Commercial Accountant

£45,000 - £55,000: Sheridan Maine: Are you a newly qualified ACA/ACCA/ACMA qua...

Laura Norton: Project Accountant

£50,000 - £60,000: Laura Norton: Are you looking for an opportunity within a w...

Day In a Page

Sun, sex and an anthropological study: One British academic's summer of hell in Magaluf

Sun, sex and an anthropological study

One academic’s summer of hell in Magaluf
From Shakespeare to Rising Damp... to Vicious

Frances de la Tour's 50-year triumph

'Rising Damp' brought De la Tour such recognition that she could be forgiven if she'd never been able to move on. But at 70, she continues to flourish - and to beguile
'That Whitsun, I was late getting away...'

Ian McMillan on the Whitsun Weddings

This weekend is Whitsun, and while the festival may no longer resonate, Larkin's best-loved poem, lives on - along with the train journey at the heart of it
Kathryn Williams explores the works and influences of Sylvia Plath in a new light

Songs from the bell jar

Kathryn Williams explores the works and influences of Sylvia Plath
How one man's day in high heels showed him that Cannes must change its 'no flats' policy

One man's day in high heels

...showed him that Cannes must change its 'flats' policy
Is a quiet crusade to reform executive pay bearing fruit?

Is a quiet crusade to reform executive pay bearing fruit?

Dominic Rossi of Fidelity says his pressure on business to control rewards is working. But why aren’t other fund managers helping?
The King David Hotel gives precious work to Palestinians - unless peace talks are on

King David Hotel: Palestinians not included

The King David is special to Jerusalem. Nick Kochan checked in and discovered it has some special arrangements, too
More people moving from Australia to New Zealand than in the other direction for first time in 24 years

End of the Aussie brain drain

More people moving from Australia to New Zealand than in the other direction for first time in 24 years
Meditation is touted as a cure for mental instability but can it actually be bad for you?

Can meditation be bad for you?

Researching a mass murder, Dr Miguel Farias discovered that, far from bringing inner peace, meditation can leave devotees in pieces
Eurovision 2015: Australians will be cheering on their first-ever entrant this Saturday

Australia's first-ever Eurovision entrant

Australia, a nation of kitsch-worshippers, has always loved the Eurovision Song Contest. Maggie Alderson says it'll fit in fine
Letterman's final Late Show: Laughter, but no tears, as David takes his bow after 33 years

Laughter, but no tears, as Letterman takes his bow after 33 years

Veteran talkshow host steps down to plaudits from four presidents
Ivor Novello Awards 2015: Hozier wins with anti-Catholic song 'Take Me To Church' as John Whittingdale leads praise for Black Sabbath

Hozier's 'blasphemous' song takes Novello award

Singer joins Ed Sheeran and Clean Bandit in celebration of the best in British and Irish music
Tequila gold rush: The spirit has gone from a cheap shot to a multi-billion pound product

Join the tequila gold rush

The spirit has gone from a cheap shot to a multi-billion pound product
12 best statement wallpapers

12 best statement wallpapers

Make an impact and transform a room with a conversation-starting pattern
Paul Scholes column: Does David De Gea really want to leave Manchester United to fight it out for the No 1 spot at Real Madrid?

Paul Scholes column

Does David De Gea really want to leave Manchester United to fight it out for the No 1 spot at Real Madrid?