Sterling set to fall as oil revenue dries up

The pound is set to come under pressure as its near 30-year status as a "petrocurrency" comes to an end, a new study predicts.

The Centre for Economic and Business Research will issue its latest quarterly business forecasts today, which will show the euro rising against sterling by as much as 23 per cent over the next four years as the balance of payments deficit continues to balloon.

The widening deficit will be exacerbated by a turnaround in the UK's net position in traded fuels. Official forecasts for UK oil production show production by 2008 will be down to 56 per cent of its peak. Gas production will also be falling at the same time, albeit at a slower rate. By 2008, UK gas production will be down to 70 per cent of its peak level.

"The result is that the £7bn trade surplus in fuel in 2000 is forecast to turn around to a deficit of about £4bn by 2008, a turnaround worth more than 1 per cent of GDP," the CEBR says in its report.

Before North Sea oil production began in the late 1970s, sterling had traditionally been a weak currency. But rising production of oil and gas from the UK's offshore fields eventually led the country to enjoy a surplus in its fuel trade worth 2 per cent of GDP by 1983. The IMF estimated this was worth a 23 per cent appreciation in sterling, which duly rose in value over the period.

"But when the underlying dynamics of slowing UK growth and the turnaround from petrocurrency status become fully understood by the markets, a fall in the pound becomes highly likely," the CEBR says.

The UK's current account deficit is predicted to reach £38.7bn by 2008 from last year's £18.8bn. The CEBR says this is forecast to reflect the lack of competitiveness of the UK economy. The benefits of a weaker currency will take time to feed through, and although higher interest rates compared with Europe will support the pound in the short term, this gap will narrow after 2006.

"If a sharp fall in sterling were to coincide with a loss of consumer and business confidence, the [Bank of England] Monetary Policy Committee would have considerable difficulty in preventing a hard landing as economic activity reaches its capacity limits," the CEBR says.