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Just how low does sterling have to go to boost exports?

By Jeremy Warner | The Telegraph | March 9th, 2010

So much for hopes of an export led recovery. You might have thought that by now the 25 per cent devaluation in sterling seen since the beginning of the crisis would have shown up in a narrowing trade gap, but no, there is still no sign of it whatsoever.

Even allowing for the icy weather, which may have disrupted exports, January’s trade figures make disappointing reading. Britain’s trade deficit, both with Europe and the rest of the world, widened considerably in January to its highest level since August 2008. Exports dropped sharply, and despite the supposed pricing disavantage of the exchange rate, imports were up too. The pound has duly taken another beating. Just how low does it have to go before there is any noticeable effect on trade?

There are a number of explanations for why the devaluation is having so little effect. The charitable one is that slow growth elsewhere makes it difficult for the UK to achieve any improvement in its external balance, however cheap, relative to others, its goods and services become. Yet this doesn’t provide a complete answer. Some emerging European markets are beginning to perform well on the back of strong exports to the eurozone.

As Kate Barker, a member of the Bank of England’s Monetary Policy Committee, pointed out in a speech on Monday, the trouble is that “manufacturing output in the UK has not so far performed any better in the early stages of recovery than has the US, Germany and France”, even though it has the advantage of a devalued currency.

Recent surveys suggest exports should soon be on an improving trend. For example, the February 2010 CIPS/Markit survey of manufacturing suggested that last month export orders grew at their fasterst pace since the survey began in 1996. So there may be a lag effect.

Rather more worrying, however, is the explanation recently ventured by Mervyn King, Governor of the Bank of England, that British companies are merely taking the extra margin in export markets afforded by the lower pound and banking the proceeds, rather than using the advantage to generate sales growth.

This is, unfortunately, what you would expect in the “deleveraging” environment we now find ourselves in. Both companies and individuals are happier to pay down debt and save than invest and spend. The effects of this phenomenon are not entirely negative.

For instance, the City, which does most of its business in dollars and euros but whose costs are largely in sterling, has suddenly found itself fantastically more profitable, so much so that the benefits of devaluation counters the supposed tax disadvantages of being in London by a considerable margin. As long as the pound remains so weak, you’ll not see the mass exodus of top bankers that some have threatened.

Yet it also highlights part of the problem. Britain’s manufacturing base has been run down to such a degree that it struggles to capitalise on the pricing advantages of devaluation. We simply don’t produce enough manufactured goods any longer. And the sort of stuff we do produce, mainly services, is not particularly price sensitive. It becomes more profitable as a result of devaluation, but does not necessarily generate more volume.

The difficulty the UK economy faces is that it is not just the private sector which is seeking to restore balance sheet health. The public sector too is desperate to reduce its deficit. If there is to be no improvement in the UK’s external balance to compensate, then prospects for growth are not good. The only way growth could be achieved is by a further deterioration in household and corporate sector.

March 9, 2010 - Posted by aletho | Economics