Exchange Rates
The Monetary Stimulus
There was no change to UK base interest rates this week with the Monetary Policy Committee holding rates at 5.0% for May. Across the Channel, the hyperactive (!) European Central Bank also kept policy rates constant for what now seems like an eternity! Thank heavens the UK remains outside the Euro Zone! Whilst policy rates are at 5% for the moment, this does not mean that monetary policy is not acting as a stimulus to one or more of the components of aggregate demand (C+I+G+X-M).
The overall stance of monetary policy includes the effects of base rate movements and also changes in the external value of sterling against a basket of other currencies. So whilst interest rates have edged lower in recent months we should also take into account the major depreciation of sterling against the Euro Zone with whome we do more than half of our trade. A falling pound acts as an important stimulus to the export sector of the economy, even though the boost is muted somewhat by a slowdown in economic growth in our export markets. Will the lower pound be a white knight for the faltering UK economy?
Cheaper sterling to the rescue?
For some time now I have been arguing that the media should be paying more attention to the exchange rate when considering the propsects for the UK economy over the coming months. A cheaper currency acts as a boost to exports and aggregate demand and can be a very useful stabiliser in an economy weakening from the fall-out from the credit crunch. There are naturally risks from a sharp downward movement in the exchange rate, not least the impact on the prices of imported products and possible flow-through effects on cost and price inflation. But taken as a whole, a lower exchange rate is what the UK economy needs at the moment - and we are getting it! Charles Bean, Chief Economist of the Bank of England made clear reference to this in an important speech in London today - it is available to download here from the Bank of England website. I have picked out one paragraph in particular which focuses on the exchange rate and compares the impact of cuts in interest rates with currency depreciations.
Currencies hit the Headlines
Two currency movements are in the news today. Firstly the pound has fallen to an eleven year low against the Euro with one Euro now worth eighty pence. The second currency hitting the headlines is the Chinese renminbi which has appreciated beyond Rmb7 to the US dollar for the first time since 1994.
Revision: The Pound Falls to 5 Year Low against the Euro
Today’s revision note is on exchange rates and is designed for AS students - the pound has slipped to a five year low against the Euro. It is perhaps the result of the Euro’s strength against the US dollar rather than any fundamental collapse in market sentiment against sterling.
read more...»Making the exchange rate less important
A fall in the external value of the currency can be manna from heaven for hard pressed manufacturing businesses looking to fight against a declining market share in domestic markets and wanting to boost their sales volumes overseas. So the recent sharp depreciation in the value of the pound sterling against the Euro has been a welcome shot in the arm for UK industry. How well placed are they to take advantage? This excellent short BBC news av clip gives students a real opportunity to evaluate just how significant is the exchange rate these days. It visits a Welsh manufacturing business that has learnt that maintaining high production quality and improving other aspects of their non-price competitiveness - including meeting tight order deadlines - can be just as important in keeping the order book full and a commercially viable price.
Fixing or Floating
In our A2 macroeconomics lesson today we were discussing the economics of fixed and floating exchange rates. The UK economy has operated with a floating exchange rate system since September 1992 and our forced departure from the exchange rate mechanism. It was an event of huge political as well as economic importance, ushering in a new system of inflation targeting and (ultimately) the granting of independence for the Bank of England. Leaving the external value of the currency to market forces does have risks, but at the moment the trends in the sterling exchange rate might well have a positive influence on the direction of the economy during a difficult 2008.
read more...»Sterling’s fall may be good news
The fall in the value of sterling could provide a timely boost for Britain’s manufacturing sector
Sterling falls against the Euro
The fall in the value of sterling against the Euro is an important macroeconomic development. No one factor explains the scale of the depreciation but part of the fall is due to expectations of lower interest rates by the Bank of England and also a slowdown in the inflow of international money that, in recent years, has come in to help finance the UK housing boom.
Over 55% of Britain’s trade is with fellow members of the European union so a change in the exchange rate against the Euro potentially has significant effects on the volume of goods and services traded between the UK and our European partners.
David Smith writes about this in his latest Sunday Times article - also available in his blog.
One aspect I hadn’t thought about when discussing the exchange rate in class today was the possible impact on the incentives for migrant workers to come to Britain to work. But the bigger picture I feel is that this could give a shot in the arm for what is left of UK manufacturing industry - exporting to the EU will become more profitable, I hope our export sectors can respond quickly.
Britain slips to 6th largest economy
A fall in the external value of the pound against the Euro is mainly responsible for the UK slipping to 6th place in the global league table for size of economy as measured by GDP. This is reported in today's Financial Times.
