Economy: Currency Fluctuations - Motion to Take Note

Part of the debate – in the House of Lords at 1:25 pm on 17th November 2016.

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Photo of Lord Bilimoria Lord Bilimoria Crossbench 1:25 pm, 17th November 2016

My Lords, BBC News reports that:

“The pound has fallen about 16% against the dollar and about 11% against the euro since June”— at one point it fell almost 20%, and that —

Chris Williamson, chief economist at IHS Markit said that despite October's CPI fall, the trend over the coming months would be upwards as rising factory costs feed through to consumers.

‘It’s … only a matter of time before price hikes in retailers’ supply chains start feeding through to the customer, as retailers seek to protect margins.

Let us not forget what caused the financial crisis in the first place. We have had the longest period of what in those days were perceived to be low interest rates of 5%. That was one of the main reasons for the financial crisis, and we have now had interest rates close to 0% for years and years propping up our economy.

The report goes on:

“Inflation has been below the Bank’s 2% target for nearly three years. Last year it was zero, the lowest since comparable records began in 1950 … Earlier this month, the Bank of England forecast that inflation would rise to about 2.7% by this time next year.”

As a result of the Brexit UK referendum and vote to leave the EU, the pound-to-dollar rate fell to a 30 to 31-year low. The Telegraph reports that:

“The last bout of volatility comes as investors switch their attention to the political risks associated with Brexit”.

It also reports that,

“the underlying cause of sterling’s fall is Britain’s woeful balance of payments position and the fundamental need for a lower exchange rate”.

Is it that, or is it Brexit, or both?

GQ reports that:

“financing a deficit of this magnitude does leave us reliant on the ‘kindness of strangers’ in the words of Mark Carney, Governor of the Bank of England”.

Sky News reports that:

“Sterling has dropped by more than 5% … against the greenback”,

in just one month and it is,

“also weaker against every other currency in the G10 group of industrialised nations”.

I was in India last week when the Prime Minister was on her visit. There were 100 rupees to the pound in June; there are now closer to 80 rupees to the pound. Sky News continues:

“Earlier this month, the deputy governor of the Bank of England, Ben Broadbent said that while the pound's plunge was helping support UK growth, Brexit uncertainty could cause an ‘insidious’ hit on the economy.

Mr Broadbent indicated that it was ‘likely’ inflation would rise over the Bank’s target of 2% over the next couple of years.

The EY ITEM Club”—

I declare an interest as I qualified as a chartered accountant with Ernst & Young and am an alumnus of the organisation—

“said the economy had been more resilient than expected following the vote to leave the European Union but this picture was deceptive.

It predicts inflation—which has been below 1% for nearly two years—climbing to 2.6% in 2017”.

There seems to be some consensus here.

The Telegraph reports that:

“UK is suffering ‘a slow motion slowdown’, says Carney”,

rather,

“than a sharp adjustment to the Brexit vote back in June”.

That is what the Governor of the Bank of England told the Treasury Select Committee. When asked if the fall in the pound was “welcomed”, Carney responded by saying, “It was necessary”, and that the sharp fall in the pound following the EU referendum will play a part in the necessary reduction in the UK’s large current account deficit, but he added that it is unclear if the decision to leave the EU means a sustainable size of UK current account has fallen.

This is much more complicated that a simple drop in the pound having an immediate effect, and I thank the noble Baroness, Lady McIntosh, for introducing this debate.

What about the impact on companies? The Guardian reports that:

EasyJet suffered a sharp fall in annual profits—its first decline in six years—and expects a further drop this year after the budget airline was hit by the weak pound and was forced to cut prices”.

Similarly, the BBC reported that,

IAG, the owner of British Airways and Iberia, says the weak pound cost it … £145m … in the third quarter of the year”.

According to Reuters:

“British bicycles to car parts retailer Halfords … said the fall in the pound following Britain’s vote to leave the European Union would remain a major challenge after it reported a 12 percent drop in first-half profit”.

Under the headline, “Sainsbury’s profits slump 10% as weak pound causes cost surge”, the Independent reported:

The Argos owner said it would still reduce shop floor prices but warned the pound’s impact was uncertain as it prepares for more expensive imports”.

Of course, we have already heard in the debate about the battle between Tesco and Unilever over Marmite. Meanwhile, “Eurotunnel cuts profit forecast due to weak pound”, according to the BBC:

“The fall in the pound after the UK referendum on EU membership has forced Eurotunnel to lower its 2016 profit forecast by 4.5% … Shares in Eurotunnel … fell 30% after the EU referendum vote and are still 16% below pre-Brexit levels”.

We have to keep in mind that the biggest UK companies, those in the FTSE 100, derive an average of 75% of their revenue from outside the UK. My own company, Cobra Beer, is in a joint venture with Molson Coors. We manufacture in Burton upon Trent, in Belgium and in India, and we export from Burton upon Trent to about 40 countries around the world. There is no question but that the weaker pound should made our exports more competitive—but does that happen immediately in the real world?

Deutsche Bank, which has just produced a report, believes that, “A weak pound won’t boost Britain because ‘economics have evolved since the Victorian era’”, according to the headline of one media report, citing the bank’s note:

“The rapid drop in the pound’s value since the Brexit vote—around 15%—will hinder rather than help British exports and the British economy, according to Deutsche Bank. David Folkerts-Landau, Deutsche Bank’s chief economist, said in a note circulated … that ‘international economics have evolved since the Victorian era’ and as a result a fall in the pound won’t automatically make British goods cheaper to overseas buyers. The note is a stern rebuttal to Brexit supporters such as … Angela Leadsom who have argued that the weaker pound will actually boost Britain but encouraging exports. Folkerts-Landau … notes that 45% of Britain’s exports are services, which”— as the noble Lord, Lord Skidelsky, said—

“are typically price inelastic—people are more driven by the quality of the service than its price. 60% of services exported are finance and business related”.

The problem here is that, as the note says,

“relatively speaking financial and other business services exports are likely to be the worst hit by a less integrated relationship with the EU”.

The article continues:

“What about manufacturing? ‘World trade no longer consists of final consumption goods being bartered for raw materials,’ he says. ‘Any economy’s manufacturing exports today contain a significant chunk of value that is added abroad’”— as the noble Lord, Lord Skidelsky, said.

The UK specialises in exporting products that have many component parts—nearly 30% of its manufactured exports are machines, engines, vehicles, and aircraft. To benefit from the fall in the pound the profit margins on these exports would have to be able to absorb the big increase in import costs of raw materials”.

The UK, as an economy that,

“adds a lot of domestic value to exports, and depends less on foreign parts, could theoretically benefit from a currency drop”.

So the simplistic thinking of someone such as Andrea Leadsom is not realistic. Our economy,

“adds only 64% domestic value to manufactured products. By contrast, Japan adds 82%, and the US adds 78% … In fact, Britain is getting worse at adding domestic value to products, as it moves towards becoming an ‘assembly line’ economy”.

The bank continues:

“The timing of Brexit is therefore unfortunate from a rebalancing perspective. The 1990s and first half of the 2000s were the golden age of globalization with global trade growing 400% over the period. Today, by contrast, the benefits of a free trade policy look less clear cut, and the UK may struggle to establish the free trade deals it needs to offset a loss of Single Market access”.

The GfK consumer confidence index edged down two points from the previous month to a reading of minus 3 for October, although it remains well above the minus 12 to which it slumped following the Brexit vote. According to the Financial Times, the Bank of England is “cautious” over the weak pound’s likely ability to boost trade, again reinforcing what I have just said. The paper reports:

“‘If devaluation was the great success factor for the UK economy, we should be the most successful economy on earth,’ said Andrew Sentance, senior economic adviser at PwC and a former member of the Bank of England’s Monetary Policy Committee, pointing to the fact that the pound was worth”— the noble Lord, Lord Skidelsky, referred to this, although I am going to go even further back—

“$5 before the second world war but has depreciated steadily and significantly since, now trading at about $1.24. The bank’s current forecast is for exports to grow by 2 per cent in 2017 and 1 per cent in 2018, while imports will increase by 0.25 per cent in 2017 and then shrink by 1 per cent in 2018. But it noted in its latest inflation report that some manufacturers ‘are particularly integrated into EU supply chains’ and that sectors such as financial services would be ‘sensitive to any changes in trading arrangements’”.

As has been said, demand for services is,

“less sensitive to price changes than demand for exported goods … boosting net trade significantly will require companies to make investments—to ramp up production of exportable goods and services and to reposition themselves as producers of currently imported items”.

Britain’s CEOs, according to a Bloomberg columnist,

“have to see beyond the buddies act and look at cold reality. Trump’s election probably won’t halt the tide of investment being delayed or scrapped, which according to a CEBR/Hitachi Capital survey totals … $82 billion … since the June referendum. They still have unaddressed fears about the U.K. economy, access to the European single market”— according to the latest survey, 92% of the British public believe we should have access to the single market—

“and the health of global trade … The U.K. economy is forecast to slow down next year while inflation is set to surge … Of the surveyed business sectors delaying investment, the top four are IT, real estate/construction, media and finance”.

We need clear direction on policy, as,

“there’s not much wriggle room … While Farage and Trump arm-in-arm may cheer Brexit’s more zealous supporters, there’s little there to put a smile on CEO faces”.

Under the headline, “The Brexit economy: falling pound and rising inflation fuel fears of slowdown”, the latest monthly Guardian analysis of a dashboard of data points to the UK economy shows that, for October,

“four of the eight categories have performed worse than expected”.

This is not encouraging. According to the paper:

“Writing in the Guardian, a former member of the Bank of England’s Monetary Policy Committee, David Blanchflower, says Britain is heading for a ‘Brexit tsunami’”.

The paper also reports:

Andrew Goodwin, lead UK economist at the forecast group Oxford Economics, also points to looming upward pressure on prices … Meanwhile the public finances worsened. The government had to borrow £2bn more than expected in September to balance the books … The International Monetary Fund is predicting the UK will be the fastest growing of the G7 leading industrial countries this year, with growth of 1.8%”,

although the IMF also,

“accepted that its prediction of a post-Brexit vote financial crash has proved overly pessimistic”,

which is encouraging.

The noble Lord, Lord Skidelsky, spoke of the balanced economy and of manufacturing going down from 30% to 10%. However, the Prime Minister has an industrial strategy. We are the second-largest recipient of inward investment in the world. One of the reasons for that is the respect for our economy, our rule of law, our institutions and our democracy. But since 23 June there has been a huge lack of confidence in this country because of the uncertainty. We have lost our AAA rating, and the Chancellor has a huge opportunity in the Autumn Statement to lower other taxes in the way that corporation tax has been, to incentivise exports. I disagree with the noble Lord, Lord Skidelsky, in that I do not think we should tax imports but incentivise exports. We should continue to encourage thriving in a global economy.

I agree with the noble Lord, Lord Paul, that we need to invest in infrastructure. Crossrail is fantastic. Heathrow is great news, although I believe Gatwick should also have been announced. All this will give confidence because the whole world does not want us to leave the EU. When I was in India, no one I spoke to—the Indian Government, civil servants, businesspeople—wanted us to leave the EU. We have to give them confidence.

As an economy, we have to be able to adapt or die. We have to invest much more than we do in our higher education and in our R&D and innovation. We need to encourage international students and academics. We need to appreciate the EU labour that we have, which benefits our economy. Then, if we have a balanced, flexible, adaptive, productive and competitive economy, we can continue, with 1% of the world’s population, to be one of the five largest economies in the world.