16 September 1992 marked the last time the UK departed from a European project – and the move turned out to be a boon for the economy. That day the government finally stopped trying to keep the pound at 2.95 deutschmarks, the rate agreed as part of the EU’s Exchange Rate Mechanism (ERM). It had raised interest-rates from 10% to 12%, and promised another hike to 15%, to make the return on sterling assets as appealing as possible.
However, market scepticism about the ERM proved overwhelming. The Bank of England sold its foreign reserves, but couldn’t stem the selling pressure in the markets. Sterling crashed out of the system and floated freely once again. Yet its fall “sowed the seeds of a better economy”, as Kit Juckes of Societe Generale told the Financial Times.
The currency slid by around 15% in just three months. Export volumes rose at double-digit rates, wiping out the trade deficit by 1995, the first time this had happened in a decade. The economy grew robustly, averaging an annual 2.9% for the next five years, and didn’t fall into recession until the financial crisis. Given sterling’s similar post-Brexit-vote decline, the question is whether we can expect a repeat performance.
One thing to keep in mind is that the extent to which sterling’s depreciation helped lay the foundation for the long 1990s growth spurt is disputed. Leaving the ERM “provided an opportunity to cut interest rates from an inappropriately high level and to do so extremely fast”, says David Smith in The Sunday Times. Rates were reduced by 4% in as many months, and “no such monetary stimulus is possible now”.
But while we may not be in line for a huge growth spurt induced by easier money, the post-ERM fall in sterling helped rebalance the economy, and a key priority now is to pivot away from consumption towards exports. So far, net trade hasn’t provided a boost to growth, but in previous sterling depreciations it has taken two years for the fall to pay dividends.
It’s interesting to note, says Roger Bootle of Capital Economics in The Daily Telegraph, that “while the official trade numbers don’t give much encouragement, the surveys of export orders, which are forward-looking, do. It looks as though by the end of the year we may be experiencing growth in exports of between 10% and 15% per annum.” Throw in the likely slowdown in imports now that consumers are lowering expenditure, and trade should soon be contributing to growth.
Portugal: don’t bet on further progress
“The prodigal son has returned,” says Marcus Ashworth on Bloomberg Gadfly. Credit-ratings agency Standard & Poor’s (S&P) has raised its assessment of Portuguese debt to BBB-, the lowest investment-grade mark, thus lifting it out of junk territory. This caps a strong run for Portuguese paper. Indeed, as The Wall Street Journal’s Jon Sindreu points out, it has been “one of the year’s hottest investments”. Anyone buying the ten-year note at the beginning of 2017 would now be sitting on a return of 22%. The yield has fallen (reflecting rising prices) to 2.5%. In 2012, it stood at 16% as investors feared bankruptcy.
S&P has hailed solid progress on reducing the budget deficit, a result of annual growth running at 2.8%. Still, investors shouldn’t count on yields declining any further, reckons Ashworth. It’s hard to see Portugal beginning to “make a dent” in the huge – and unsustainable – overall debt pile of 135%, and the European Central Bank, which has been hoovering up Portuguese debt with printed money, now owns almost a third of it – the maximum permitted under the quantitative-easing programme’s rules.