Trade figures for January released today show little evidence of the economic benefits promised by the many advocates of exchange rate devaluation.
Contrary to the script, net exports appear to be exerting a drag on the economy in early 2009. Excluding oil and erratic items, export volumes in January were 8% below their fourth-quarter level versus a 5% decline in imports.
Meanwhile, manufactured import prices climbed a further 1% in January to stand 14% higher than a year before. Ongoing sterling weakness suggests the annual rate of change will remain in double-digits – see chart. As argued previously, the import price surge has lifted underlying inflation, thereby partly offsetting the boost to real incomes from lower energy prices and the VAT cut.
The weaker exchange rate may also have worsened the credit crunch by encouraging foreigners to reduce their sterling bank deposits and eroding banks’ capital ratios by inflating the sterling value of their foreign currency assets. Foreign net lending in sterling to UK-based banks fell by £63 billion between August and January. Credit constraints may have prevented some exporters from taking full advantage of the falling currency.
Sterling has weakened again following last week’s MPC decision to embark on “quantitative easing”. While this policy change is warranted, it carries inflationary risks from a possible further large fall in the exchange rate. These risks would have been reduced by smaller interest rate cuts, greater fiscal discipline and less “talking down” of the currency by policy-makers.
