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Your Money > Travel Insurance Articles > Six reasons why...
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By Richard Evans
The British economy is going to hell in a handcart - or at least you could be forgiven for thinking that, judging by the pound’s dramatic loss of value against other currencies. After all, sterling has fallen from over $2 and about 1.5 Euros to about $1.44 and 1.12. There is another side to the story, however. For one thing, interest rates - a major influence on exchange rates, as investors chase the highest returns - are higher in the euro zone than here. The dollar, meanwhile, is something of a special case, as it is seen as the world’s benchmark currency. Sterling has actually risen against some other currencies. But even if the verdict of the foreign exchanges on sterling is justified, having a weak currency is not automatically a bad thing for the economy. Here are six reasons why sterling’s devaluation could be a blessing in disguise. 1. Exports get a boost When the pound falls against the euro, say, goods made in Britain become cheaper for European buyers. This is because they will need fewer euros to buy the amount in pounds needed to make the purchase. So where previously it might have made sense for the buyer to choose a locally made product, the fall in the price of the British competitor in euro terms could make that the cheaper option. Overall, the British manufacturing sector should become more competitive and win more business without cutting its prices in sterling terms. This should help to prevent severe job losses that might otherwise occur in some industries. Better still, exactly the same applies to services that are sold overseas. So if a British-based web designer, for example, is bidding to carry out some work for a company in America, he can charge his usual rate in sterling while his customer needs less in dollars to buy those pounds. "A weak pound increases the competitiveness of British exporters and so boosts sales of UK exports in overseas markets – especially when the drop in the pound is as sharp as that seen over the past few months," says Vicky Redwood of Capital Economics, the consultancy. 2. Home-produced goods become more competitive British goods and services also win in the domestic market. This is because the price of imports goes up in sterling terms, as we need more pounds to buy the requisite euros or dollars for goods produced overseas. So British companies selling to the domestic market should find it easier to win business against foreign competition, again helping to prevent mass redundancies. “Imports become more expensive, so British consumers spend more on domestically produced goods and services,” says Redwood. This effect, along with the boost to exports, should have long-term benefits for the economy, she adds. “After a decade or so where the economy was reliant on consumer spending to drive it forward - which resulted in a dangerous build-up of household debt and record low saving rates - the lower pound should help economic growth to be more evenly balanced, preventing the re-emergence of such high debt levels.” 3. Tourism in Britain is encouraged This can be seen as a special case of the effects noted above. A domestically produced service - in this case holidays - is cheaper for overseas buyers than before, encouraging them to come here. For British consumers, holidays at home will become better value when compared with overseas trips, whose cost will on average have risen because the pound buys less abroad. Foreigners on holiday in Britain boost our retail sector, as well as the tourism industry, helping to protect jobs and earnings in these parts of the economy. Visitors find goods on sale here relatively cheap because their dollars and euros buy more pounds. “Some parts of the high street could benefit from overseas tourists coming here,” says Henk Potts of Barclays Wealth. “It’s a long time since London was seen as a cheap city.” He points out that Pontins and Butlins, two holiday companies catering largely to the domestic market, are doing well as more British people take their holidays in this country. “I’ve heard that Europeans are coming here to buy Harley Davidsons, as we used to go to Germany to get BMWs,” adds Potts. “Overall, a weak currency can definitely help economic recovery. This happened in America a year ago.” 4. Income earned by British companies and individuals overseas becomes more valuable Many of the companies in London’s blue-chip stock market index, the FTSE100, are international rather than purely British and earn large proportions of their profits abroad. Such dollar- and euro-denominated earnings are worth more when brought back the this country and converted into pounds. Given how large a part these companies are of the British corporate scene, this effect is a significant one. “London’s blue-chip companies used to be UK plc, now they are more international companies,” says Potts. “The oils majors and our big drugs makers - oil and drugs are priced in dollars - and the big London-listed miners: all are massive foreign exchange earners,” he adds. “Corporate profitability could fall by 20 per cent this year but some of this could be offset by currency effects.” Vodafone, for example, recently said it expected its full-year profits to be boosted by £500m because of sterling’s weakness. Everyone is affected by the health of the stock market, even if they don’t hold shares directly. Pension funds, private pensions and savings products such as unit trusts and endowment policies all invest in shares to some extent. Private investors with assets overseas can also benefit from sterling’s weakness. British people who own shares or property abroad will see income such as dividends or rent worth more in sterling terms, while the capital gain from selling the assets will also receive a boost from the exchange rate. 5. Deflation is held back Inflation is usually seen as a bad thing but many economists say that deflation - falling prices - is even worse. The economy can enter a vicious cycle of falling consumer demand as people wait for prices to fall further, leading to unemployment and further downward pressure on wages and prices. A fall in the value of sterling against other currencies is inflationary, because imports rise in price, as do some domestically produced goods as many components and raw materials are imported. So a weak currency can help ward off the onset of harmful deflation. 6. City bonuses get a boost Many will question whether this is a benefit, given that bankers are now held in lower esteem than bank robbers, but City bonuses play a large role in London’s economy and many small businesses would suffer if bonuses fell drastically. Because these bonuses are often paid in foreign currencies, however, sterling’s weakness makes them worth more when converted into pounds. Porsche dealers and Fulham estate agents will be breathing sighs of relief. Useful links: |
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