This hammering is hardly surprising, given the 17 per cent rise in the pound against the German currency since the beginning of August, a period when the dollar has weakened by about 5 per cent. Against many markets where prices are at best flat or falling, currency moves of this magnitude mean that internationally traded products made in Britain suddenly become uncompetitive or overseas earnings slump, or both. Whichever way you look at it, the fundamentals for a large swathe of British manufacturing industry have taken a dramatic turn for the worse.
BZW measures this effect by tracking the value of what it calls the "real pound", a trade-weighted index that gives an indication of the relative competitiveness of British industry. According to the resulting chart, UK plc has lost all the extra competitiveness it gained after sterling fell out of the exchange rate mechanism in 1992. BZW says British exporters have not faced a steeper challenge in the past 10 years.
This is reflected in the very narrow base on which the current bull run in the stock market is based, with domestically oriented financials and utilities leading the charge and manufacturers underperforming badly. Such a defensive strategy by investors is entirely consistent with the welter of downgrades, mostly linked to currency, which have hit the market over the past couple of months. Earnings forecasts for the whole market have come down a couple of points from as high as 13 per cent to as low as 9 per cent since the middle of December.
But while many of Britain's export industries will undoubtedly suffer real pain as a result of the pound, at least some of the currency woes may be overdone. For a start, many sectors, like the big drugs groups and to a certain extent the conglomerates, will only be affected on the translation of their overseas' subsidiaries' earnings into sterling. There are no real bank balance effects.
More importantly, the strength of the pound is unlikely to be sustained if, as some believe, the prospects for interest rate differentials start to narrow and the UK's current account starts to deteriorate. If that proves to be the case, the current weakness could become a buying opportunity later this year. Many analysts believe that manufacturing will start catching up with the current buoyancy on the high street in the second half. Even after downgrading for currency effects, brokers Credit Lyonnais Laing are still looking for manufacturing production to rise a healthy 2.2 per cent this year.
But even if investors are not brave enough for such a strategy, there should be plenty of beneficiaries of the pound's strength. Laing's Corey Miller points out that 49 per cent of the turnover of UK plc is domestic. Many of those companies, particularly in the food retailing, and building sectors, will see their margins widen as raw materials priced in foreign currencies get cheaper.
Companies dependent on the UK consumer will also get a boost if, as BZW's Richard Kersley suggests, the strength of sterling, combined with recent uninspiring economic statistics, keeps interest rates lower than most observers currently expect. He thinks expectations that base rates will be 7 per cent by the year-end may be too pessimistic. Likely beneficiaries of a lower cost of money would be financial companies and those vulnerable to movements in the housing market.
If sterling remains high, and one serious forecaster posed the question last week of whether the pound would reach DM3, other areas to watch might be food producers, which often buy their raw materials in relatively cheap foreign currency, importers, whose products (cars for example) become more attractive, and holiday companies. Eurocamp said last week the strength of the pound against the franc would help it this year after a disastrous year last year when France was perceived as being too expensive.Reuse content