Not the Euro

January 24, 2013

Britain’s relationship to Continental Europe has always been a restless one.  Britain approached the Common Market late, not joining until 1973, and the island nation is now contemplating the possibility of leaving the European Union unless its rights and responsibilities as a member can be renegotiated.  Britain has twice abandoned participation in joint European currency floating arrangements, first in 1972 and more infamously in 1992, and the government opted out from participating in the euro.  This yearning for exceptionalism has at times serviced the U.K. constructively, and so it seemed in 2009-12 when the common currency was embroiled in crisis.  But in these early days of 2013, it appears likely to be a liability rather than an asset to define sterling as the Un-euro.

Pessimism toward the pound has become fashionable.  A proliferation of articles in the press this month are warning that sterling could be a big loser in 2013, and it’s not hard to cite unfavorable contrasts that set Britain apart.  While disinflation is still observed in most developed economies, British inflation stubbornly remains above the Bank of England’s target.  Fiscal austerity has not reduced the government deficit, so the Tory-led government is doubling up on its thus far failed strategy rather than reevaluating its wisdom.  The U.K. current account deficit is also chronically excessive, and monetary officials are believed hopeful that sterling will depreciate to more competitive levels.  Since the Great Recession, Britain simply hasn’t mustered escape velocity for a self-sustaining recovery.   A triple-dip recession now beckons even as the U.K. remains comparatively far below its levels prior to the financial crisis.

The arguments compelling British politicians toward a break with the EU are more passionately ideological than coldly objective.  Potential costs of leaving Europe are understated, and proponents of British sovereignty have an exaggerated sense of U.K. economic superiority.  The Bank of England’s inability to contain inflation in recent years as well as other central banks harkens back to the 1970’s when inflation was chronically in double digits and above 25% in mid-1975.  Who can forget that Britain was forced by market pressures to devalue sterling in 1967, borrow from the IMF in 1976 and abandon the European Monetary System’s exchange rate mechanism in 1992?  Britain’s political leaders, unlike before, no longer enjoy a specially close relationship with their U.S. counterparts, and the U.K. coalition partners are getting along poorly, creating yet another source of potential vulnerability for the exchange rate.

With just three and a half weeks of 2013 gone by, sterling already has fallen pretty sharply.  From 2013 highs of $1.6380 and 0.8085 per euro, it had dropped 3.8% against the dollar and 4.7% against the euro at today’s lows.  Since the euro’s launch at the start of 1999, sterling has traded as high as $2.1160 on November 9, 2007 and as lowly as $1.3505 on January 23, 2009 (just four years ago).  Relative to the euro, it has ranged from a high of 0.5688 on May 3, 2000 to a low of 0.9803 on December 30, 2008.  Over the whole 13+ years, the pound’s average values were $1.6684 and 0.7266/EUR, each stronger than the currency’s present levels.  The points is to take away from these ranges is that sterling is already in the southern hemisphere of its travels but that it can depreciate considerably further before entering unchartered territory.

Looking forward to the next couple of months, sterling should be viewed as a foil to the euro, because that’s the lens that the country is choosing to use.  Improved sentiment toward the euro can be observed directly in its rebound of more than 10% from a 2012 low of $1.2041 and versus the euro’s all-time high/low range mid-point of $1.2133.  Better euro sentiment can also be seen indirectly in the greatly reduced peripheral euro sovereign debt spreads vis-a-vis Germany.  Unless one expects the euro to take a decisive general turn for the worse soon, one should probably anticipate further tough sledding for sterling.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.


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