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One Year on from Brexit.. Do not lament Sterling weakness..

Friday, June 23rd, 2017

Sterling is down 13% on a trade weighted basis since the Brexit vote.  This has helped manufacturing orders to hit their highest level since 1998 according to data out today.  Sterling’s decline is beginning to help the revival of manufacturing and dampening consumer spending through higher inflation. 

Sterling weakness is rebalancing the economy away from (indebted) consumer spending and towards manufacturing and exporting (hopefully although the UK export strength is in services where there are far more trade restrictions and less trade liberalisation). 

Do not lament Sterling weakness. 

It is therefore highly timely for Labour supporter and founder of consumer goods firm JML, John Mills, to publish his book this week – “Britain’s Achilles Heel – Our Uncompetitive Pound”.  As John Mills notes “we have a chronic Balance of Payments problem.”.  His solution is a much weaker pound – even from here.  Mark Carney in his Mansion House speech referred to it as “relying on the kindness of strangers” and said it is a serious weakness of the UK economy.

If (and it is an IF) Sterling weakness reduces the trade deficit significantly, this is a good thing.

However the concern is that Sterling weakness increases inflation – the last CPI print was higher than expected at 2.9%.  However I truly don’t believe it will head much higher.  Although forecasting CPI is a mug’s game, I think a weak oil price will do much to dampen inflation.

The oil price has collapsed in the last month from almost $55 for WTI to $43 now.  US shale producers are learning how to be more efficient and to produce at lower prices.  This has meant that the US crude oil industry last week reported almost record production.

I love a chart and this one form the US Energy Information Administration shows weekly US production of crude oil going back to 1985:

US oil production

As you can see there was a decline in production from mid 2015 to mid 2016 after the oil price collapsed from over $100.   But more important is that the OPEC November production cut has had no impact at all on US crude production which has risen back to almost record levels.  Higher US production means lower oil prices.

Something else that may dampen the oil price is the growing aggressiveness of the House of Saud.  Saudi Arabia has taken on Qatar and demanded Al Jazeera been closed.  With Trump’s supposed backing, it may now take on Iran.  Both Qatar and Iran are members of OPEC.   That is going to make negotiations on production cuts difficult.

Post the Anglo-Saxon crisis, Sterling fell and CPI got to over 5%, but that was also due to a soaring oil price.  This time a dampened oil price may actually mitigate the impact of a lower sterling on inflation.  If that is the case, a little above average inflation dampening some consumer demand, with all the benefits of a much weaker sterling boosting UK manufacturing and exports, is a good mix.  

And the external environment is right too.  Firstly UK exporters are pushing against an open door as the global economy now is expanding faster than at any time since the crisis.  And secondly UK businesses are likely to think that sterling could last for many years as the uncertainties of Brexit play out.  So persistent Sterling weakness should be a lasting boost to UK competitiveness.

For all those who argue that a weak Sterling is bad for the UK, look at quite how beneficial a weak Euro has been for Germany.  

This chart is the Germany current account (largely the trade account but with a few extra factors) as a percentage of GDP.  Note the Euro was introduced in 1999:

german current account as % GDP

Up to the introduction of the Euro, Germany, like the UK, ran a currenc account deficit.  Replacing the strong Deutschemark with a far weaker Euro has enabled Germany to turn that from a deficit to a surplus.   And a huge surplus at that – at a whopping almost 9% of GDP.  For comparison, at its worst the UK current account deficit got to over 5% – a level deemed deeply worrying.

And this has enabled Germany to become the power player of Europe.  The corporate tax revenue from German exporters booming has enabled the state to run a fiscal surplus this year.  The chart above enables Germany to have power and wealth.

Like John Mills, we should be cheering a weaker currency, the Germans have


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