Sterling has been gaining strength since July last year, rising 13.64% against the US dollar. The UK currency's strength has been driven mostly by stronger-than-expected economic growth at home, weaker US macro data in the first quarter of this year, and the Bank of England's (BoE) monetary policy slowly approaching normalization.
Some from within the UK manufacturing and export industry argue a stronger pound could pose a threat to exports and trade. The Confederation of British Industries (CBI) said in its latest survey that "export orders underperformed in the latest quarter, which may in part be because of the strength of sterling."
Persistently weak trade data and deficits on trade in goods resulted in the second largest current account deficit in the last quarter of 2013, equating to 5.4% of total GDP, before slightly improving in the first quarter of this year.
In his most recent speech, Bank of England (BoE) Deputy Governor Ben Broadbent said sluggish global economic growth is among the primary reasons for the UK's meager trade balance, while the overall current account deficit and its structure should not pose an 'existential' threat to UK growth.
"If the global economy remains sluggish, it will inevitably be harder for an open economy like the UK to achieve both strong and balanced growth," Broadbent said to an audience at Chatham House in London on July 29.
Berenberg UK chief economist Robert Wood, a former BoE official, said today that world growth matters more for exports than the exchange rate. "Exports are not sensitive to the exchange rate," Wood said.
"As sterling did not boost exports much after 2008, sterling’s recent rise will not drag much either. Indeed, the past improvements in competitiveness could well continue to aid growth in future. If world growth improves, UK firms may take advantage of more competitive sterling to export more," Wood added.
To support the above argument, we should go back to the BoE's Monetary Policy Committee (MPC) minutes from January 2013 which revealed that policymakers argued with similar logic – and that global growth not the currency was behind poor UK trade data, even at the time of a substantially depreciated sterling between 2007 and 2008.
"The contribution of net trade to UK economic growth since the large depreciation of sterling in 2007 and 2008 had continued to be disappointing. While it had contributed 0.5 percentage points to GDP growth in the third quarter, net trade had made a small negative contribution over the preceding year as a whole. The lack of a more significant improvement in the trade performance of the UK economy could partly be explained by slow growth overseas," the January 2013 MPC minutes read.
According to the BoE, a stronger sterling helps to keep consumer prices in check as import prices were probably starting to pull down Consumer Price Index inflation.
On the other hand, if the central bank wanted to lower the value of the pound, it would have to keep the base interest rate at a record low for longer, which Berenberg analysts argue "would push inflation higher than otherwise and quickly erode the competitiveness gain. Monetary policy cannot durably improve competitiveness."
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