First with Financial Comment from Arabia

25% devaluation a high price to pay for UK growth

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Goldman Sachs is forecasting a stronger than average turnaround in the fortunes of the UK economy this year but only because the value of everything in Britain has been devalued by 25 per cent with the collapse of the pound.

This seems a high price to pay for 3.4 per cent growth which Goldman thinks the UK will achieve in 2010, although not many other forecasters are as optimistic. This will compare to 2.4 per cent growth in the USA and 1.9 per cent in the eurozone.

Devaluation bonus

The fall in the value of sterling is expected to boost export growth, and attract inward investment from overseas. There are also hopes that the important UK financial sector will revive investment spending after last year recording the lowest level since the 30s.

However, export volumes will first have to make good the value lost in depreciation. Then there is a reliance on a continued upward movement in the global economy to support rising exports and inward investment. A double-dip US or eurozone recession would sink this prospect, and keep the UK financial sector on its knees.

The Goldman forecast is also predicated on a much longer period of ultra-low US interest rates than most economists accept, with effective zero rates until 2012. This would help to keep the pressure off the Bank of England to raise its rates.

However, foreign currency traders say the pound’s weakness may not last for long, and UBS is telling its clients to buy the pound against the euro. In that case the window of opportunity for UK exporters may close as quickly as it opened.

UK house prices

Some recovery in the UK housing market recently might also be seen as a harbinger of higher growth rates, with investment from overseas a factor at the top-end. But equally this is a sign of interest rates now set at dangerously low levels that are bound to result in unsustainable asset price inflation.

That is to say house prices that will come down quickly when interest rates finally go up. However, 2010 is surely a year of two halves for the UK economy: before and after the general election expected in May and by the latest in June.

Whichever party or coalition of parties is elected is going to have to raise taxes and drastically cut public spending and borrowing. That will dampen demand and return the economy to conditions that feel like a recession even if it is technically avoided. For no economy in history has ever devalued its way to growth in the long run.


Written by Peter Cooper

January 19, 2010 at 11:08 am

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