Belfast Telegraph

Why UK deficit plan has real value when it comes to exchange rates

By John Simpson

The exchange rates for sterling with the US dollar and the euro are two of the most critical influences on business in Northern Ireland and also on the cost of living.

Any marked depreciation of sterling hits a range of import prices, from the prices for petroleum products to imported animal feed prices.

In the first half of 2012, in the foreign exchange market, sterling has experienced a stressed environment.

There has been a marginal depreciation relative to the US dollar, recently trading at near to £1=$1.55. This is close to an average of nearer to £1=$1.60 in recent years.

The near stability with the dollar is better than might be expected given the change in other economy variables.

A double dip recession (even only a small secondary dip) along with high unemployment and a too large and persistent government deficit suggests the economy is performing inadequately by any comparable experience in recent years.

A number of factors are helping to sustain the exchange value of sterling.

First, the international currency markets accept the credibility of the UK Government's deficit reduction policies and related policies to manage the economy. This is an important strength and also a constraint. The UK Government must avoid (or minimise) any Plan B which relaxes the public sector spending squeeze.

The Northern Ireland Executive can expect little financial relief given the reductions in the Block Grant. Northern Ireland has been treated reasonably fairly and equitably by the Treasury. No regional Plan B is expected.

Second, sterling is protected from the currency fears for countries that are within the eurozone. The difference between belonging to the EU and being part of the eurozone has become very important.

The public demonstration of this distinction when the Prime Minister voted to stand outside efforts to set-up the European stability pact had little real impact but the demonstration effect was significant.

Nevertheless, the recent evidence of poor discipline in the upper reaches of the UK banking community needs to be tackled.

The evolution of the euro as a core currency for 17 members of the EU has taken the exchange markets by surprise.

With the clarity of hindsight, the euro was launched with a superficial appreciation of the complexity of currency management across 17 or more countries. Expecting rational national macro-economic policies without an agreed disciplinary process was naive.

Somewhat perversely, the surprise is that the exchange rate for the euro has been less vulnerable than might have been expected, when assessed alongside the very major international deficits incurred (for different reasons) by countries such as Greece, Portugal and Ireland, now Spain and possibly France.

The anchor to the euro has been the influence of the German economy.

Of course, the euro: sterling rate has varied.

From an initial launch period when the relationship was near to €1 = 65p, the underlying trend was for the euro to strengthen. In the middle of the last decade, speculation was whether there might eventually be parity of €1 = £1.

From a Northern Ireland perspective, the most critical exchange rate factor is the fate of the euro (and its exchange value).

Currently a rate of €1 = 78p shows some euro depreciation. If the eurozone holds together and Ireland remains a member, as seems likely, then business and tourism in Northern Ireland must expect some discomfort.

Will the eurozone collapse? Probably not, but that is not assured. Will Ireland successfully remain in the euro? Probably, but there is uncertainty for Greece.

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