The British Pound's Party Won't Last Much Longer: Matthew Lynn
March 3 (Bloomberg) -- In the past few weeks, British newspapers have run stories about the bargains to be scooped up by anyone heading to New York for a weekend's shopping.
A Feb. 20 headline in the Guardian ran: ``How the sickly dollar has spawned a shopping bonanza, New York style,'' while the story drooled over how you could pick up Jimmy Choo shoes for 302 pounds (about $575 when the article was written) compared with 360 pounds in London.
``Land of the Spree,'' reckoned the Mirror a day earlier. Its story pointed out that you can fly to the U.S., buy an iMac computer from Apple Computer Inc., and still save 100 pounds on making the purchase back in the U.K.
At $1.83, the pound is still close to its highest levels against the dollar in 11 years. It exceeded $2 in September 1992. In November 1980 it touched $2.44. And if your memory stretches back to March 1972, you'd find it at $2.64. Still, by any historical standards, the pound is now trading at high levels.
That doesn't look like it will change soon. Brian Hilliard, director of economic research at Societe Generale SA in London, forecast on Monday that 1 pound would soon be worth $2.
What's good for bargain-hunters looking for some cheap jeans or computers, however, is not necessarily good for the British economy.
A pound at $2 is going to put the U.K. economy on the rack. The trade deficit will widen. The consumer boom will get even more fevered. And the imbalances in the British economy -- between the people who make things and the people who consume things -- are going to worsen.
Benign Neglect
Britain has been pursuing a policy of benign neglect of the pound. The Bank of England has shown no desire to get the currency's external value to fall. If anything, by increasing rates to 4 percent, it has been the source of sterling's strength.
At its last meeting, the Monetary Policy Committee discussed the strength of sterling, but so far has not seen it as a reason to put a lid on rising interest rates. SocGen's Hilliard points out that some MPC members were ``suggesting that it could be treated as a `one-off' shock `which should be disregarded in setting interest rates.' The more sterling rises, the harder it will be to persist with this argument.''
Politicians have been just as relaxed about the strength of sterling. John McFall, the chairman of parliament's treasury committee, said last month the U.K. government wouldn't do anything to curb the increase of the pound, even if the currency went to $2 or more. Tony Blair, the British prime minister, agrees. At a press conference in February he ruled out intervention. ``It's not our intention to intervene in the market in relation to the pound,'' Blair said.
Tightlipped Politicians
That's a marked contrast with the rest of Europe. German and French leaders have been trying to talk the euro down, even if they have yet to follow their words with action. The U.K. has a disastrous history of currency management. Most British politicians would rather own up to tax evasion than express any kind of opinion on the pound.
Still, the wisdom of that course is questionable. Just because nobody wants to talk about it, it doesn't follow that the high level of the pound isn't going to cause problems.
While manufacturing may be recovering along with the global economy, British company profits are getting hurt. GlaxoSmithKline Plc, Europe's largest drugmaker, said in February that its earnings per share may be reduced by 7 percent this year if the dollar stayed at its current level. Pearson Plc said this week that 2003 revenue at its education unit, the company's largest, declined 11 percent, partly because of currency movements.
`Natural' Rate
Meanwhile, the trade deficit remains stubbornly large. It was 4.2 billion pounds in December, slightly down on November. For the whole of 2003, it came to 46.4 billion pounds, almost at the level it was in 2002.
In the past year, the pound has moved a long way from a realistic exchange rate. There is no ``natural'' exchange rate. It always depends on the state of the markets. Still, a rate of $1.40 to $1.60 would reflect the relative purchasing power of the two currencies.
When an economy is out of balance, at some point it has to snap back. That is seldom a smooth or easy process. The more out of balance you are, the rougher it is.
The foreign exchange markets are like men and relationships. They ignore all the problems for a very long time, then they suddenly get in a terrible state for no apparent reason. They ignored the U.S. trade and budget deficits for a long time. Now they are obsessed with them. Right now, they're ignoring the British trade and budget deficits (economists surveyed by the Treasury expect the budget shortfall to amount to about 37 billion pounds this fiscal year). At some point, the markets will notice those twin deficits and start hammering the pound.
Rough Patch
When it happens, expect the U.K. economy to hit a rough patch. Strong sterling has depressed manufacturing, while boosting demand for cheap imports, creating a retail and consumer boom. A fall in sterling will throw that into reverse.
At the same time, once sterling starts to fall, the Bank of England may have to keep interest rates high to make sure foreign money flows into the country to finance the trade and budget deficits. The Federal Reserve can ignore the decline of the dollar because governments hold the currency as a reserve. Nobody has to hold pounds. And if they see the U.K. currency fall, they won't want to buy it unless they're tempted with very high interest rates.
Everyone hopping across to New York for some new Jimmy Choo shoes may soon be celebrating the $2 pound. But at some stage, sterling has to go down again -- and when it does, it won't be a pretty sight.
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