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Wednesday, 16 April 2014

Pound fall

Moody's shaming brings UK gain in currency war

The only question had been which rating agency would shoot first. Moody’s did the deed, removing the UK’s triple-A rating on Friday. It is a political humiliation for the UK government, but the downgrade also removes that lingering expectation of being gunned down. The irony is that the humbling may help the UK achieve recovery sooner - and without firing another monetary policy shot in the currency wars.

The downgrade sets events in course. Fiscal policy is unlikely to change much. George Osborne, the chancellor, will remain constrained by the poor prospects for the deficit. And bond yields will not jump. Similar downgrades of the U.S. and France made little difference. When debtors are weak and yields absurdly low, a ratings cut deters few investors.

The pound, though, is a different story. Sterling was already down when the rating agency kicked. It fell sharply on the news of the downgrade and is at risk of falling further to $1.50. The euro could climb to 90 pence, taking the pound close to its 2009 ultra-lows. That’s bad - for exporters to the UK.

For British producers, a weak currency is good news. The latest CBI industrial survey reports UK manufacturers finding much stronger demand in home markets and, to a lesser extent, export ones. A yet-weaker pound will help. A sector that has been a big drag on growth may be reinvigorated.

Less helpfully, the weaker pound will show up quickly in prices. Inflation, now 2.7 percent, is very likely to head well over 3 percent. Yet this too may alleviate an uncertainty. Bank of England Governor Mervyn King and two others sabotaged sterling this month by voting for yet more quantitative easing. But higher inflation will stiffen resistance to QE in the nine-man monetary policy committee. Mark Carney, the incoming BoE governor, will find it harder to lead them into QE carnage in July, should he be so inclined.

Lack of growth and rising debt spurred Moody’s downgrade. The downgrade may itself do something to help growth. But Moody’s looks wise to have judged the downcast UK’s outlook as stable, not negative.

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Context News

The pound sterling fell to a 31-month low against the U.S. dollar of $1.51 and a 16-month low against the euro, making the euro worth 87.4 pence, following Moody’s downgrade of the country’s triple-A sovereign rating late on Feb. 22.

The Confederation of British Industry reported a “significant improvement” in manufacturers’ order books in February. It reported that 21 percent of manufacturers responding to its February survey said total order books were above normal, while 23 percent said they were below. The resulting rounded balance of -3 percent is well above the long-run average of -18 percent.

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