How Gordon Brown’s financial mis-management is hurting the pound
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It seems the Bank of England just can’t please anyone.
It cut interest rates yesterday by a quarter point, which was basically what everyone had been expecting. But it hedged the cut with a warning that inflation looks like it could well spike higher in the months to come.
The suggestion that the Bank isn’t going to panic and follow the Federal Reserve in throwing caution to the winds, sent the FTSE 100 plunging. It ended the day down by more than 150 points, at 5,724.
But at the same time, the pound also plunged against the dollar, despite clear implications that UK interest rates will remain well above those in the US for a long time to come. So what’s going on?
The UK stock markets plunged yesterday because the Bank of England’s comparatively gentle pace of rate cuts has disappointed traders. But the pound took a dive too, shedding almost two cents against the dollar. Judging by recent years, you would normally expect the promise of higher interest rates to prop up the currency rather than knock it down.
However, now it seems that currency traders are starting to pay less attention to interest rates and take more of a view on which countries are heading for recession. They are hoping that the rapid action (or blind panic) on the behalf of the Fed will make any US recession shorter and shallower.
I can’t say I agree with this assessment – as I’ve mentioned before, consumers are now in balance-sheet rebuilding mode. You can’t force people to borrow more money if they don’t want to, regardless of how cheap you make it, and you also can’t force banks to lend if they are worried about their balance sheets too.
So for my money, cutting interest rates drastically at a time like this is pretty futile, and merely encourages higher inflation expectations.
UK or US: which would you rather invest in?
But it goes deeper than this. At the end of the day, if both the UK and the US are heading for recession (or in one, in the case of the US), which of those countries would you rather be invested in, assuming you had to have your money in one of them?
It’s going to be the US every time. It might be running into serious trouble, but it’s still the world’s biggest and most important economy. So if you’re an international investor who’s feeling panicky about your investments in the West, then the US will still be the place you’re most likely to divert assets to.
And of course, Britain is rapidly losing its reputation as a safe home for your money. The Northern Rock debacle took on whole new significance yesterday when the Office for National Statistics decided that £100bn would have to be added to the national debt to account for the taxpayers’ funding of the bank. The ONS is basically treating Northern Rock as a publically owned company, like the Royal Mail. This makes sense, as of course, without the government propping it up, Northern Rock would have gone bust.
Now the move doesn’t change much in practical terms, but it does look very bad for the government. It means that Gordon Brown’s rule on sustainable investment has gone completely by the wayside. He always wanted to keep national debt to less than 40% of GDP, but this takes it to 45% - above the US.
The rules were of course, always a bit of smoke and mirrors to give economists and journalists a theoretical bone to chew over while Mr Brown got on with the serious job of squandering the country’s money on health service middle management jobs.
Why sterling looks vulnerable
But as Ambrose Evans-Pritchard points out in The Telegraph, it’s the reputational damage that “may prove to be the final straw for the UK’s government bond market.” He quotes Andrew Guy of ADG Capital Management as saying that “we are approaching the point where Asian and Middle East investors are going to charge a much higher premium for holding British sovereign debt. Once a government loses credibility, these investment shifts can happen with alarming speed.”
If foreign investors lose faith in the government’s ability to manage our economy, then they could rapidly pull out, hurting sterling even more, and driving up inflationary pressures. That would make the Bank’s job even harder, and it’s another reason why Mervyn King can’t follow Ben Bernanke’s strategy for staving off recession.
The dollar is still a hugely important global currency – the US can still (just) afford to say, “the dollar’s our currency, but it’s your problem” to international investors.
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Sterling, unfortunately, is entirely our problem.
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