The Business World: Tony's euro stance allows business a chance
Sterling behaves as though it was linked to the US dollar ... because the UK economy behaves just like the US economy, rather than the Continental ones
Wednesday 23 June 1999
First and most obviously we can assume that UK monetary policy will continue to be set with the needs of the British economy in mind.
We were always assured this would happen, but there were nagging doubts there might be pressure to try to cut the value of the pound against the European currencies by converging UK interest rates to European levels.
So if the economy starts again to expand strongly we can expect rates to rise to trim the growth; if the economy falls off sharply next year (perhaps following economic disruption associated with the millennium bug) then we can expect rate cuts to maintain demand. Second, we can also assume, I think, that sterling will continue to behave as though it were linked to the dollar.
If you looked at the way the currency has performed since it was cut free from the ERM in 1992, you would assume that policy has been to peg it instead to the dollar. Every time the pound has moved outside the $1.50 to $1.65 band it has swiftly come back into it. Now this is not policy at all, but more the result of the fact that the UK economy behaves like the US economy rather than the Continental ones, but until it starts to behave differently we should assume that the "dollar peg" will remain.
If this is right, what happens to our economy will be closely tied to what happens to the US one. If the latter hits the limits of capacity and slows suddenly, we can expect to face similar difficulties. Whether the scale of any downturn in the US will be matched here is another matter: the boom here has been less marked, the current account is still more or less in surplus, stock market values are less extreme, and we (unlike the US) have already had a pause in growth last winter. My guess would also be that when and if the US economy turns down, the UK one will also do so, but to a less extreme extent.
How might that effect our trade relations with Europe?
We do not know how the euro will perform in the next five years. It is easy to sympathise with the current view of the European Central Bank that the euro is undervalued against the dollar, and hence against sterling. But the under valuation (a) may not be very large and (b) may be sustained for a long time, a decade or more, if the main continental European economies do not improve their performance.
The key here is the largest of the euro-zone economies, Germany. In theory, a cheap currency ought to stimulate the big European economies: a cheap German mark has been the usual way the German economy revived, on the back of a rise in exports. But with a single currency for the whole zone, the cheap euro now helps Germany exports only to areas outside the euro- zone. So the currency affects about 11 per cent of its GDP, instead of nearly 30 per cent. A cheap euro helps, but not as much as a cheap mark would have done.
Still, there will be some growth in continental Europe this year and next. Currencies overshoot their "correct" values, so the euro will recover and the dollar will decline. British business should therefore not assume the pound will stay strong for ever against the euro; the prudent assumption is that it will stay reasonably strong for some time yet.
Will inward investment in Britain suffer because of continued exclusion from the euro-zone? It would be surprising if there were not some hesitation, particularly since some foreign businesses will assume sterling may never be abandoned for the euro.
But if the UK economy continues to show strong demand and if UK plants remain profitable on the back of this, then it would be surprising if there was a serious slump in inward investment. That would be a powerful argument in favour of membership. On the other hand, expect the euro-zone to continue to experience teething troubles as a result of the difficulty finding an interest rate which fits all: some economies will continue to overheat (Ireland, Spain, and the Netherlands) and others will continue to suffer (Germany and Italy). So exporters to the continent should know their markets will experience bumps in demand as different countries adjust by other means than monetary policy.
Will exclusion from the euro-zone for the time being have other effects on the UK? I suspect it will reinforce a trend already evident for Britain to focus on markets tied by language and culture rather than physical proximity.
We will increase exports and imports from the US, Canada, Australia and probably Scandinavia (which also appears to be tied more closely to the US than to the Continent). These products will tend to be in new areas such as software - weightless products - if they are products at all, for much of the growth in exporting will be in the service industries. Britain is already the world's second largest exporter of services, after the US.
So is the end of uncertainty about the euro (or at least the postponement of uncertainty) good or bad news for the British business community?
For the large companies it may appear to be bad news. Many large companies, particularly European-owned ones, like to operate without much exchange risk.
Small businesses, on the other hand, will welcome the freedom that independent monetary policy gives the UK authorities, particularly if that freedom is matched by similar flexibility on tax and regulation.
In terms of employment, keeping an independent currency is almost certainly positive, for it is these small businesses that are net creators of jobs. Large ones, under constant pressure to slim their workforces, are net destroyers.
So good news or bad news? That depends in which corner of the commercial forest you find yourself, but the ending of the uncertainty surely deserves a modest cheer.
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