Strong GBP/EUR Exchange Rate Fails to Halt UK Export Order Surge

newton-smith impact of strong pound exchange rate

Above: Rain Newton-Smith, the CBI's Economics Director, says UK manufacturers are reporting improved export orders. Image (c) CBI.

The latest CBI Industrial Trends Survey shows UK manufacturers are at their most confident in 7 months.

The same report also highlights a strong uptick in export orders - this despite the British pound (GBP) being at its strongest level in 8 years against the euro on global foreign exchange markets.

This is a significant finding as the Eurozone is the United Kingdom's largest trading partner and accounts for the bulk of export demand. The general rule of thumb is that high exchange rates tend to price a country's good out of the international markets.

UK main export markets

“Export orders picked up significantly, to a level not seen for six months, but uncertainty over prospects in the Eurozone will continue to weigh on export demand. So, it’s imperative we continue to help manufacturers sell their products and services into high-growth markets around the globe,” says Rain Newton-Smith, CBI Economics Director.

Is the British Pound Overvalued?

At the time of writing the pound to euro exchange rate (GBP/EUR) is trading 0.12 pct higher on a day-to-day basis having reached 1.3578. The GBP/USD is meanwhile trading lower at 1.5385.

The data presented by the CBI suggests the strength of the pound exchange rate complex is yet to be impact negatively on British manufacturing.

However, Andy Scott at HiFX says he expects the strength of the pound to eventually weigh on activity unless the Bank of England tackles it:

“One thing we haven’t heard the Bank of England's MPC mention yet is the strength of sterling over the past year, which reached a multi-year high on a trade weighted basis – even though it’s weakened against the U.S. dollar.

“A strong currency when you’re faced with disinflation can add to the problem, and we see this as something that’s likely to register on the BoE’s radar in the months ahead.”

But, is Scott right about the GBP being overvalued?

Firstly, Scott recognises that the pound dollar exchange rate is not in contention as it has fallen over recent months.

As we mentioned, the Eurozone is the UK’s largest trading partner and the pound to euro exchange rate is at an 8 year high.

So arguments over sterling strength would be focussed on the GBP/EUR and export activity with Eurozone customers.

Long-term studies of the GBP/EUR exchange rate show that the currency pair is by no means overvalued:
pound to euro long term history

As the chart suggests sterling is merely recovering from an extended soft patch and the levels above 1.40 are historically justified.

While exporters would always prefer a softer currency to make their goods more attractive on the international stage we believe they can - and will have to - absorb a stronger exchange rate.

As such, we doubt the Bank of England would seek to talk down the GBP and unnecessarily complicate its remit.

UK Manufacturing Robust

Activity in the manufacturing sector picked up pace in February, and output is expected to grow faster still in the next three months, according to the latest CBI Industrial Trends Survey.

The survey of 522 manufacturers found that total order books strengthened on already robust levels, climbing to a six month high.

40% of firms said the volume of output over the past three months was up and 23% said it was down, giving a balance of +17%.

This brought the pace of growth to levels last seen in mid-2014.

Export orders also rallied this month, to a level well above average, regaining some of the ground lost towards the end of last year.

However, they still lag behind more robust domestic orders.

Growth in output volumes rose in February, reaching their highest level for seven months, and 16 of the 18 sectors anticipate growth in the coming quarter.

Manufacturers expect a modest rise in selling prices over the next three months, although expectations for price inflation remain moderate on the whole.