On the rise and rise of sterling: When a high pound is inevitable, rela x and enjoy

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The Independent Online
WE SLUNK unto our corners and licked our wounds when sterling was heaved out of the ERM, so why aren't we crowing now that the pound is soaring back up above its old ERM level? Why are we not crowing about the even more remarkable fact that the British stock market is now worth more than the Japanese?

The obvious reply to the first question is that for some parts of the economy - manufacturing exporters in particular - the strong pound is making life very tough. But this undoubted pressure has not stopped a German company paying over the odds for a well-known British motor manufacturer called Rolls-Royce. It has not stopped shares on the London market from bouncing around close to their all-time record. And it has not stopped the investors who continue to pile into our currency - helping push the overall value of London above Tokyo.

Sterling's new-found status as a safe haven, a calm solid asset in an uncertain world, may seem a bit odd to those of us who recall the days when the pound was worth $2.80. But the current status does raise some profound questions - like "why?", "how long will it stay up?" and "does it really matter?"

For the answer to the "why?", I spoke yesterday with a wise New York banker, who seems to spends his life going round the globe telling the world's rich where to put their money, and who happened to be passing through London. The gist of his reply was this.

There were, he said, very few ports of call. The world is awash with liquidity, and most investors were full of dollar assets and wanted to diversify their risks. European currencies? Well, all the uncertainty about the Euro certainly damped enthusiasm, but in any case Europe was seen as an equity play, not a currency one. Everyone expected there to be a wave of mergers and take-overs as companies reorganised themselves in preparation for EMU. In two years the euphoria would be over as the inevitable downsizings followed, but for now you bought European shares. On the other hand if you wanted to park money somewhere you did that in sterling because that was where there was a decent yield.

This may not seem a very flattering reason for investing in sterling, but I don't think many of us expected foreign money to come in because of the delights of Cool Britannia. The fact that we have a competent government and a vigorous private sector is taken pretty much for granted, which in itself is a remarkable change from 20 years ago. But the undoubted appeal of sterling is largely the result of relatively high short-term interest rates in a world where rates generally are very low.

This would suggest that the strength is a short-term phenomenon and that sterling's present level is unsustainable. That would be the mainstream view and my American banker did reckon that things felt "a bit overblown". But there is a substantial minority view that the pound will remain pretty strong for quite a while yet. The high interest rates which are buoying it up are not an artificial prop, but rather a necessary response to a strongly-growing economy. Some day the economy will turn down and we will get lower interest rates, but I'm not sure that situation will be widely welcomed when it comes. Meanwhile the prospect is for higher rates still, for the economy carries on a brisk canter.

Even when the down-turn in rates starts, whenever that may be, it is perfectly plausible that sterling will remain a strongish currency. In fact, assuming we keep it, the pound may remain fundamentally strong for a generation or more. That would seem to be the only safe assumption that our exporters should make, and accordingly they should plan to adapt to cope.

That leads to the "does it matter?" question. The manufacturing lobby is well-organised and has had no difficulty in making its fears heard. But manufacturing is only a small portion of the economy - about one-fifth. The other four-fifths tend to benefit when the pound is strong: we gain from lower prices, cheaper holidays, a generally higher standard of living. Were sterling absurdly high there would be a genuine cause for alarm, but at the moment UK wage costs are still considerably lower than those in France and Germany, so we cannot be that far out of line.

Some wise UK manufacturers actually welcome the strong pound. I was talking with an American executive the other day about the firm's UK subsidiary. The great advantage of the strong pound, he said was that it forced the local UK management to bring in all sorts of measures to improve efficiency that head office wanted and it had previously been resisting. Why didn't you force them, I asked. Well, we couldn't because the pound was so low that, even with the inefficiencies, they were still making excellent profits, he replied.

This need to maintain discipline over costs is the greatest benefit that a strong currency provides. Gordon Brown pointed out in his budget speech the need to lift UK productivity to the levels of the best in the world. The crucial element in lifting productivity in Germany and Japan has been the relative strength of the currency, forcing any company wanting to export to use its largest input, labour, as efficiently as possible. Our exporters, by contrast, tended to be bailed out by successive devaluations of the pound. The surge of sterling in the early 1980s started the process whereby British companies were forced to began to narrow the productivity gap, but as the Chancellor acknowledged there is still some way to go.

So we've got to learn to live with high exchange rates. There's not much the Chancellor or the Bank can do to bring the pound down for now, and anyway it's a consequence of our buoyant economy. So what should we do? I suggest we enjoy it. I'm off abroad next week, and I intend to do so.