Whether you call it a currency war or not doesn’t matter. The collapse in the value of the euro since the announcement that the European Central Bank was planning to launch its own version of quantitative easing (QE) has been dramatic. The currency has tumbled to $1.05 and £0.71, and may go lower still.
Already there are signs that it is working. Confidence is starting to rise among European manufacturers as their order books start to fill up on the back of a cheaper currency. Unemployment is falling. Even in burnt-out Italy, house prices are starting to gain some momentum.
From a very low base, the eurozone is beginning to look a little healthier. So the ECB president, Mario Draghi, is probably feeling quietly pleased with himself.
The weaker euro will hurt us
The trouble is that a currency devaluation comes at a cost. It is essentially beggar-thy-neighbour economics. So who will suffer most from the weak euro? Unfortunately, it’s going to be us. Britain is the eurozone’s largest export destination: the UK accounts for 13% of all eurozone exports, compared with 11.8% for the US, 6% for Switzerland, and 5% for China.
It is also the major destination for our exports. Britain accounts for 9.75% of the eurozone’s imports, second only to China, which accounts for 12.75% of everything the bloc buys from the rest of the world.
So the fall in the value of the euro is a major problem for the UK. Our exporters are suddenly going to find it a lot harder to compete in European markets. Everything they sell will suddenly have become a lot more expensive. At the same time, eurozone companies are going to find it a lot easier to sell stuff here, taking orders away from British competitors.
At precisely the point in the recovery where you would hope that exports and business investment would help the economy build some momentum, it is about to get a lot tougher. The trade deficit, already a growing problem for the UK, is set to get worse.
At the moment, we seem content to stand by and watch that happen. We shouldn’t be. Yes, it’s hard to control exchange rates. And a currency devaluation can be a double-edged sword. But that does not mean we are powerless to protect ourselves from the euro collapsing, the pound soaring, and the damage that would do to our economy. There are a number of ways that we could start looking after our own exporters.
First, we could, in the parlance of the currency markets, start to “jawbone” the pound down. The markets listen to what central bankers have to say. A powerful speech from Mark Carney about how the pound is too high will help make a few traders nervous about selling the euro too much.
Carney has already edged towards that, making some remarks about the strength of sterling last week, and the impact that was having on lowering inflation. But he could go a lot further. A speech arguing that 1.5 euros to the pound was as high as he was prepared to let the currency rise would make a difference – even if it did not have any details on what he might do about it.
Secondly, take interest rates negative. The Swiss and Danes have already started imposing negative interest rates in an attempt to prevent their currencies appreciating too far against the euro. True, that may seem weird, but it helps deter floods of speculative money pouring into your currency because it costs to keep the cash on deposit.
It might not be obviously what the UK needs – most of the arguments are currently about when to raise rates – but it would prevent the pound from getting too expensive.
Thirdly, try another blast of QE here. Although the Bank of England has not mopped up all that extra cash it created under its own QE programme, it is more than three years since it printed any more money.
QE always depresses a currency – that may be the main mechanism through which it works. So another £500bn of QE this year would take the steam out of the pound’s upwards acceleration. True, it might overheat the housing market – but then, there are few policy options that come without any costs.
Let the EU know we’re not happy
Finally, use political pressure. The UK is not a member of the euro, but it is part of the European Union. It’s surely not right that the eurozone dumps deflation on this country, or uses a devalued currency to export its way out of trouble at the expense of our trade balance and manufacturers.
We could tell the rest of the EU that the ECB has a duty to pay attention to the sterling-euro exchange rate and to make sure it does not move too far out of line with its historic norms. The Germans would do precisely that if it was their manufacturers who were getting hit. So would the French. There is no reason we shouldn’t as well.
None of those paths will be easy. Nor will they necessarily work. It is an unusual position for the UK to be in – normally our currency is too weak, not too strong. But each of them may well make some difference. And some action is needed. If the pound gets too strong against the euro it will do a lot of damage to a recovery that is still very fragile.