14
ECONOMIC SUMMARY
Devalued sterling may prove
a blessing in disguise
BY IAN KERNOHAN,
ECONOMIST, ROYAL
LONDON ASSET
MANAGEMENT
The pound certainly looks
cheap on some long-term
fundamental value measures
such as purchasing
power parity: you only
have to travel abroad to
realise how expensive even
basic items seem to be,
which is often as good a
measure as any of an
undervalued currency.
Yet history suggests a
currency can remain over-
or undervalued on these
measures for a considerable
period of time, at least
until a catalyst comes along
to trigger a correction.
As so often when
making predictions, strong
arguments stack up on
both sides of the debate.
We think the Bank of
England will be more
active than either the ECB
or Fed this year in withdrawing
some - and I
emphasise ‘some’ - of the
unprecedented monetary
stimulus which it has
applied to the UK economy
over the past year. We
feel that the latest GDP
data underestimates the
momentum in the economy
since last summer, mindful
that estimates can be
revised, often years later.
The yield differential
between UK and German
two-year government
bonds has had a fairly
good correlation with sterling’s
value against the
euro recently and we
Sterling has enjoyed
substantial currency
depreciation over
the past couple of
years, but what are
its likely prospects
from here on?
counter counterpoint point
would expect sterling to
move higher against the
euro this year, though still
retain most of its devaluation
gains since 2007.
I use the word ‘gains’
advisedly: lower sterling
is an important economic
safety valve for the UK,
something that neither
Ireland nor Greece – so
keen to join the single currency
when it was set up
– possess.
On balance, a flexible
currency and the recent
devaluation will prove to
have been a good thing for
the UK, in the same way
as Black Wednesday in
1992 is now referred to by
many as White Wednesday
– with one bound, sterling
was free.
What might go wrong in
our modestly bullish sterling
scenario? Politics and
the deficit loom large. A
downgrade to the UK’s
credit rating, perhaps provoked
by a hung parliament,
would not be sterling
supportive. Also, there is
always the risk that momentum
in the economy slows
again and leads the Bank of
England to keep policy on
hold for the rest of the year,
or even extend quantitative
easing further.
United Kingdom
■ The UK is officially out of recession with its
provisional GDP figure growing by 0.1% in the final
quarter of last year.
■ The government borrowed £4.3bn in January – the first
time it had to do so in January since records began in
1993 – as tax receipts dropped by 11.8% year on year.
■ CPI soared to 3.5% in January, up from 2.9% in
December, pushed up by the return of VAT and higher
oils prices; RPI rose from 2.4% in December to 3.7%.
■ Unemployment remained at 7.8%, though there was a
slight dip in figures, down by 3,000 to 2.46 million for
the three months to December.
United States
■ The US economy grew by 5.7% in Q4 last year, up
from 2.2% in Q3. Its GDP fell by 2.4% for the full year.
■ The Federal Reserve is predicting economic growth
of between 2.8% and 3.5% for 2010, while its
unemployment rate is expected to remain around 9.6%
before dropping to 8.5% next year.
■ US imports grew by 14.8% pushing its trade deficit up
to $40.2bn (£25.5bn) in December, 10% higher than in
November and the largest for a year.
■ House prices rose for the sixth consecutive month in
November, growing by 0.2% on October’s level.
Japan
■ Japan’s policy is for prices to rise by 1%, but
consumer prices fell by 1.2% in December, the
largest drop since CPI began in 1970. Interest rates
remain just above zero.
■ Its GDP grew by 1.1% in Q4 last year, while its economy
contracted by 5% for the whole year. Consumer
spending rose by 0.7% on Q3, while corporate spending
increased by 1%, its first growth since March 2008.
■ Japanese firms doubled their capital investment in the
rest of Asia to $25.5bn in the year to March 2009,
slightly below their US investment level.
PORTFOLIO ADVISER [www.portfolio-adviser.com] MARCH 2010
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