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
ebooksA special investigation by Andy McSmith
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

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

iJobs Job Widget
iJobs Money & Business

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE £45,000: SThree: SThree Group have been well e...

Ashdown Group: IT Manager / Development Manager - NW London - £58k + 15% bonus

£50000 - £667000 per annum + excellent benefits : Ashdown Group: IT Manager / ...

Recruitment Genius: Sales Consultant / Telemarketer - OTE £20,000

£13000 - £20000 per annum: Recruitment Genius: Scotland's leading life insuran...

Ashdown Group: Training Programme Manager - City, London

£40000 - £45000 per annum + benefits : Ashdown Group: Training Programme Manag...

Day In a Page

NHS struggling to monitor the safety and efficacy of its services outsourced to private providers

Who's monitoring the outsourced NHS services?

A report finds that private firms are not being properly assessed for their quality of care
Zac Goldsmith: 'I'll trigger a by-election over Heathrow'

Zac Goldsmith: 'I'll trigger a by-election over Heathrow'

The Tory MP said he did not want to stand again unless his party's manifesto ruled out a third runway. But he's doing so. Watch this space
How do Greek voters feel about Syriza's backtracking on its anti-austerity pledge?

How do Greeks feel about Syriza?

Five voters from different backgrounds tell us what they expect from Syriza's charismatic leader Alexis Tsipras
From Iraq to Libya and Syria: The wars that come back to haunt us

The wars that come back to haunt us

David Cameron should not escape blame for his role in conflicts that are still raging, argues Patrick Cockburn
Sam Baker and Lauren Laverne: Too busy to surf? Head to The Pool

Too busy to surf? Head to The Pool

A new website is trying to declutter the internet to help busy women. Holly Williams meets the founders
Heston Blumenthal to cook up a spice odyssey for British astronaut manning the International Space Station

UK's Major Tum to blast off on a spice odyssey

Nothing but the best for British astronaut as chef Heston Blumenthal cooks up his rations
John Harrison's 'longitude' clock sets new record - 300 years on

‘Longitude’ clock sets new record - 300 years on

Greenwich horologists celebrate as it keeps to within a second of real time over a 100-day test
Fears in the US of being outgunned in the vital propaganda wars by Russia, China - and even Isis - have prompted a rethink on overseas broadcasters

Let the propaganda wars begin - again

'Accurate, objective, comprehensive': that was Voice of America's creed, but now its masters want it to promote US policy, reports Rupert Cornwell
Why Japan's incredible long-distance runners will never win the London Marathon

Japan's incredible long-distance runners

Every year, Japanese long-distance runners post some of the world's fastest times – yet, come next weekend, not a single elite competitor from the country will be at the London Marathon
Why does Tom Drury remain the greatest writer you've never heard of?

Tom Drury: The quiet American

His debut was considered one of the finest novels of the past 50 years, and he is every bit the equal of his contemporaries, Jonathan Franzen, Dave Eggers and David Foster Wallace
You should judge a person by how they peel a potato

You should judge a person by how they peel a potato

Dave Hax's domestic tips are reminiscent of George Orwell's tea routine. The world might need revolution, but we like to sweat the small stuff, says DJ Taylor
Beige is back: The drab car colours of the 1970s are proving popular again

Beige to the future

Flares and flounce are back on catwalks but a revival in ’70s car paintjobs was a stack-heeled step too far – until now
Bill Granger recipes: Our chef's dishes highlight the delicate essence of fresh cheeses

Bill Granger cooks with fresh cheeses

More delicate on the palate, milder, fresh cheeses can also be kinder to the waistline
Aston Villa vs Liverpool: 'This FA Cup run has been wonderful,' says veteran Shay Given

Shay Given: 'This FA Cup run has been wonderful'

The Villa keeper has been overlooked for a long time and has unhappy memories of the national stadium – but he is savouring his chance to play at Wembley
Timeless drama of Championship race in league of its own - Michael Calvin

Michael Calvin's Last Word

Timeless drama of Championship race in league of its own