IS it a bird? Maybe even a plane? No, what you see is Superpound, and you may
even have some in your wallet. Sterling has climbed to a 26-year high of
$2.02 against the dollar, boosted by the expectation of higher interest
rates in Britain, which the Bank of England duly delivered on Thursday
lunchtime.
When currency traders assess whether to buy or sell, the pound ticks most of
the right boxes. The economy looks strong, of which more below, and there is
no sign that the appetite for higher interest rates of the monetary policy
committee (MPC), or at least most of its members, has been satisfied.
The performance of the pound under new Labour differs markedly from
predecessors. Every previous Labour government endured sterling crises: the
abandonment of the gold standard in 1931, the devaluations of 1949 and 1967,
the IMF crisis of 1976. This one has had a strong pound that is getting even
stronger.
Sterling’s rise against the dollar, the “cable” rate, exaggerates its overall
strength. Since early last year the pound is up by nearly 30 cents. But
there is also some broader-based strength. The pound’s average value,
measured by the sterling index, has risen by 5% over the same period.
In one respect, the Superpound story is a simple one. For a few months last
year we had the unusual situation in which British interest rates were below
those in America. The Bank’s surprise January rate rise to 5.25% restored
parity between UK and US rates and subsequent increases have taken British
rates higher. Normal service has now been resumed and the chances of further
hikes here are greater than in America. When interest rates do come back
down, America is likely to lead.
The European Central Bank left its interest rates unchanged at 4% on Thursday.
Japanese rates are close to zero. Canada’s Bank rate is 4.5%. UK interest
rates are the highest in the G7.
The New Zealand dollar has risen 28% over 12 months, on the back of a rise in
interest rates to 8%. High-yielding currencies are attractive to
international investors, particularly when they borrow cheaply in yen, the
carry trade. Sterling is getting some of that.
But the sterling phenomenon is not just about its rise against a sagging
dollar. Michael Saunders, an economist with Citigroup, has been tracking its
growing importance as a reserve currency. Sterling was the original reserve
currency until about 1914, held by other governments, central banks and
international institutions.
It then went into decline, along with the UK economy, overtaken in importance
by the dollar, D-mark, yen and even the French franc. But sterling has made
a comeback and has been the fastest growing reserve currency in recent
years. The dollar is still the world’s leading reserve currency, by a mile,
accounting for almost two-thirds of holdings, followed by the euro with a
quarter. But sterling’s share has risen to 4.5% from 2.1% 10 years ago and
moved ahead of the yen.
IMF data show identified holdings of $156.9 billion (£77.7 billion) of
sterling. But, according to Saunders, this does not take into account those
nations where reserve holdings are not broken down by currency. Add these,
and sterling reserves on his estimate are nearly £134 billion, up more than
£20 billion on a year ago.
The rise in sterling reserves is part of a wider phenomenon. UK assets have
become more attractive to international investors. Figures from UK Trade &
Investment (UKTI), the government body, showed that Britain had another very
strong performance during 2006-7, with a total of 1,431 inward-investment
projects, up by 17% on a year earlier. This was the third record year in a
row.
Of these, 23% were expansions of existing investments, 42% were new, and 35%
mergers and acquisitions. Inward investment, it appears, is unequivocally a
good thing. The latest year’s projects created over 36,000 new jobs and
safeguarded a further 41,000. According to UKTI, two-thirds of investments
were by innovative or R&D-intensive firms. The great threat of firms
deserting Britain for tax reasons has come to little; 200 foreign firms
established UK headquarters in 2006-7.
Surely, however, there must be some downside to Superpound, and even to this
flow of inward investment. Exporters suffer when sterling is strong and some
fret about “UK plc” being snapped up by foreign bidders.
But there is another potential downside, highlighted by research at Nottingham
University’s Globalisation and Economic Policy Centre (GEP). It suggests
that inward investment has the effect of killing off promising start-up
businesses in Britain, particularly innovative new firms.
The research, by Andrew Burke, Holger Görg and Aoife Hanley, highlights the
strong rise in the share of UK employment in foreign-owned multinationals,
from 12% in 1998 to 17%. Inward investment is beneficial, it says, in
so-called “static” industries, where technologies are well established and
where its effect is to improve efficiency and bring down prices. But in
fast-changing “dynamic” industries, inward investment has its sinister side.
“The chance to attract a big company and hundreds of jobs to the UK may make
the demise of a new enterprise seem unimportant, but the impact could be
enormous over the longer term,” says Görg. “The companies being killed off
are the Microsofts and Virgins of the future. Many promising start-ups are
being snuffed out before they have a chance to develop competitive
resilience.”
There is no easy answer to this but it is a reminder that actions have
consequences, and risks. We may be quietly proud of Superpound as a national
virility symbol. And the government would face a wave of criticism if the
inward investment stopped coming in and there was a drain of head offices.
But at some stage these inflows will fade, and with them sterling’s
strength. Only then will we really know how well we are doing.
PS: Attempted terrorist attacks, floods, torrential rain, hailstones the size
of golf balls (the old smaller ball, that is), the most-disrupted Wimbledon
on record – a gloomy time. Then along comes the Bank, like a grim, grey
countenance, to add to it. Central banks are supposed to take away the
punchbowl when the party gets going, not pile on the misery at a wake.
I would not have raised interest rates on Thursday, as I wrote last week. It
seems to me that some members of the MPC, including the governor, were stung
by more than they cared to admit by having to write an explanatory letter in
April in response to March’s inflation rise above 3%. What was, until then,
a calm and measured response has suddenly become aggressive.
Retailers are genetically programmed to moan about trading conditions but for
once their pain is real and, according to the British Retail Consortium,
intensifying. The summer sales have come early, and the discounts deeper
than usual. You don’t sell many little strapless numbers when the weather is
cold and wet – I haven’t bought any.
You may say that this is just anecdotal and that as the weather improves the
picture will be transformed. But the data are also convincing. Median pay
settlements continue to average only 3.5%, confirming the benign wages
picture. The growth in real household incomes has ground to a halt and the
saving ratio is at a 47-year low of 2.1%. If this does not add up to a
significant spending slowdown I would be astonished.
Even in the housing market, where the picture on prices is mixed, the seeds
of a slowdown are there. To the extent housing is fuelling strong growth in
the money supply, incidentally, this may be more technical than real; a
function of the fact that after a period of sharply rising house prices,
those entering the market have much bigger mortgages than those leaving it.
The economy is not going to fall off a cliff, particularly with the global
picture so strong. But domestic demand looks to have slowed and will slow
further. The Bank has demonstrated its aggressiveness. It now has to be wary
of the dangers of overkill.
david.smith@sunday-times.co.uk
