Economics Weekly - Recovery in UK exports holds key to future growth; Weekly economic data preview - BoE MPC to provide further detail behind decision to halt QE
Economics Weekly - 8 February 2010
Recovery in UK exports holds key to future growth
The sharp fall in sterling over the past
three years and the nascent signs of recovery in the global economy provide an
opportunity for growth that the UK cannot afford to miss. With the
household and corporate sectors weighed down by high levels of indebtedness,
and the public sector about to embark on a substantial fiscal squeeze, the
prospect of a meaningful recovery in domestic demand over the coming years is,
we believe limited. Instead, to achieve a reasonably strong and sustained rate
of growth means it is not only desirable, but essential, that the UK rebalances away from debt driven domestic
demand towards net exports. The competitive boost provided by the fall in
sterling, and the steady recovery in global demand, provide this opportunity.
Since peaking in January 2007, sterlingâ€™s
trade weighted index has fallen by around twenty-five percent. While the
trade-weighted exchange rate has recovered a little over the past year, the
overall decline over the past three years represents the largest correction in
the exchange rate since the UK withdrew from the ERM in the early
1990s. As chart a shows, the decline in sterling has been most acute against
the yen, with GBP/YEN having dropped by around almost 70% over this period.
Nonetheless, against the US dollar, euro, Swiss franc, and a host of emerging
market currencies, sterling has also fallen sharply.
To the extent that a fall in the exchange
rate raises import prices and lowers export prices, one might expect the fall
in sterling to be associated with a marked improvement in the UKâ€™s trade position (the difference between
the amount we export and import, in current prices). But, as chart b shows, the
improvement in the UKâ€™s trade balance in recent years has been
Since early 2007, the UKâ€™s total trade deficit in goods and
services as a proportion of gdp has improved by just over 1 percentage point
(pp) to 2.2%, driven by a reduction in the visible (goods) trade deficit. While
the current trade deficit is not out of line with the experience of the last
decade, it remains troubling that the UK export sector has not yet responded more
strongly to the fall in the exchange rate, particularly given the fragile backdrop
to domestic demand. This is particularly so, as a large part of the improvement
in the UKâ€™s trade deficit has been the result of a
sharp fall in imports, reflecting weak demand conditions at home. This source of
improvement cannot be sustained indefinitely, and a meaningful recovery in the
UKâ€™s export performance will be required if the trade balance is ultimately to move
back into surplus territory - as it did briefly in the mid-1990s, following
sterlingâ€™s exit from the ERM.
So why has the UKâ€™s trade position not improved more sharply?
Part of the reason may be that the competitive boost has occurred against the
currencies of those countries which undertake relatively little trade with the UK (see chart c). For example, UK exports to Japan, Switzerland and Brazil account for only 4% of total exports.
However, against the currencies of our
largest trading partners - the major euro zone countries and the US - the drop in the exchange rate has
still been substantial. Against the euro and US dollar, sterling has dropped by
around 25-30% since earlty 2007 - far more than it has against many of the
developing economy currencies. It seems that rather than increasing market share,
therefore, UK exporters have used the opportunity of the
weaker exchange rate to rebuild profit margins. Indeed, over the past three
years, export prices have risen by almost 25% (se chart d).
The UKâ€™s terms of trade is the ratio of its
export prices to its import prices. As such, it measures how many units of
imports the UK can buy with one unit of exports. Other
things being equal, a fall in the exchange rate might be expected to lead to a
deterioration (i.e. fall) in the UKâ€™s terms of trade, as import prices rise and
export prices fall (and vice versa). As chart d shows, however, the UKâ€™s terms of trade has actually improved
slightly over the past three years. In other words UK export prices have risen relative to import
prices, despite the fall in sterlingâ€™s exchange rate over this period. The improvement
in the terms of trade, it seems, has limited the recovery in UK export volumes.
The experience of the past three years
contrasts with the experience of the UK in the early 1990s, when export volumes
responded more aggressively to the fall in the exchange rate. Indeed, it was
the boost to UK net trade during this period that was
instrumental in raising real incomes and bringing the UK out of recession. It remains to be seen
whether the same will occur this time around. It may not if export prices do
not fall. However, the lags between exchange rate movements impacting on trade
volumes can be substantial. Companies, for example, may be locked in to
multiyear fixed price contracts; they may be wary about lowering their export
prices for fear that the decline in the exchange rate could be short-lived;
and/or they may need to widen margins to help protect their balance sheets.
Notwithstanding the above, we are hopeful
that the UK will respond to the opportunities that
arise from the fall in sterling and the signs of global economic recovery. Indeed,
the marked improvement in the export orders balances of the latest CBI SME
Trends and manufacturing PMI surveys provide grounds for
optimism. According to the January PMI
survey, manufacturing export orders are currently at their highest level since
this data were collected in 1996. Although the share of manufacturing in gdp
has fallen markedly over the past thirty years, there remain many industries,
in both the goods and services sectors, in which the UK has a comparative
advantage - chemicals, business & financial services, engineering and
biosciences, to name but a few. If the UK is emerge from the downturn with a
stronger and more stable economy over the medium to longer term, it is
essential that this rebalancing away from domestic consumption towards net
Adam Chester Senior UK Macroeconomist
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Weekly economic data
preview - 8
BoE MPC to provide
further detail behind decision to halt QE
ô€‚„ Following on from last weekâ€™s decision
by the MPC to halt its programme of quantitative easing, attention will shift
to the detail of its quarterly Inflation Report (published on Wednesday), which
would have been a key input into the MPCâ€™s deliberations. Key themes arising
from the statement accompanying the policy decision announcement was that the Committee
thought recent monetary policy initiatives would continue to â€śimpart a
substantial monetary stimulusâ€ť to the economy, although it acknowledged that
should the recovery falter, it could restart the programme of asset purchases. We
expect the detail of the Inflation Report to strike the same tone and show that
the MPC is very much in â€śwait and seeâ€ť mode. On dataflow, the BRC retail report
is released on Tuesday. The January CBI retail report was downbeat, with the VAT
rise and inclement weather negatively impacting activity. Our forecast for a two
percentage point fall in the annual rate of BRC total sales growth (to 4%) is
also a reflection of these factors. We expect the headline trade balance (also Tuesday)
to be unchanged at ÂŁ6.7bn, while industrial production data (Wednesday) are
expected to post a 0.3% decline in December. That would be consistent with the
sectoral output data within the ONSâ€™s preliminary GDP estimate released last
month, which showed that the industrial sector grew 0.1% over Q4.
ô€‚„ Financial markets will be closed in the US on Monday for the Presidentsâ€™ Day holiday.
Although there are no major economic releases on Tuesday, the sale of $40bn of
3yr notes by the Treasury will be closely watched. Given the recent weakness of
global equities, we expect to see strong appetite from investors. The main data
highlight this week is provided by the January retail sales figures on
Thursday, which will provide an early pointer for consumer spending and growth
prospects in the first quarter. We look for a modest gain of 0.3% in headline retail
sales and excluding autos of 0.5%, rebounding after surprise falls in December.
It is worth highlighting though that the monthly data are notoriously volatile.
The University of Michigan consumer sentiment index, published on
Friday, is expected to show a further modest gain in February, reflective of
the improving labour market. We expect the headline index to breach the 75
for the first time since January 2008.
However, after the news of a further fall in non-farm payrolls last month,
focus will also be on the latest initial jobless claims data on Thursday,
particularly following the surprise gain seen last week. We look for a sharp
fall to 445K in the week to February 6, from 480k previously. The other major
release in the US this week is the December trade balance
on Wednesday. We look for a modest narrowing in the trade deficit to $36bn,
from $36.4bn, on stronger exports. The data will also be used to refine
estimates of US Q4 2009 GDP growth.
ô€‚„ At the recent ECBâ€™s press conference,
Jean-Claude Trichet was noticeably more upbeat on the subject of Greece and the efforts being made to repair its
public finances. So there was more than a touch of irony when stock and bond
markets registered significant falls shortly afterwards, apparently on the back
of concerns over contagion effects from the eurozone periphery. As far as the
spread of 10-year government bond yields over equivalent bunds is concerned, Portugal and Spain have also moved into the limelight.
Preliminary Q4 GDP releases feature strongly in this weekâ€™s euro-zone economics
data calendar. At the aggregate euro area level, we look for an outturn of
+0.4% quarter-on-quarter, yielding an annual rate of -1.9%. National data from Germany, France and Italy are published on the same day, Friday.
Broadly speaking, exports and inventories remain the key drivers of euro-zone
economic activity, although these components clearly do not guarantee seamless
recovery. Other economic releases include December industrial production
figures for the euro-zone (along with national data for Germany, France and Italy).
George Johns (UK Macroeconomist), Jeavon Lolay, (Senior
Global Macroeconomist, Mark Miller (Global Macroeconomist)
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