UK chancellor Norman Lamont supposedly sang in the bath after sterling was ejected from Europe’s exchange rate mechanism in 1992. That ultimately spelt the end of the Conservative government. But sterling’s fall also laid the foundations for a multi-year economic recovery. Today, however, a fall of similar size has failed to deliver the same magic. Manufacturing remains depressed and exports poor. Indeed, it is this – rather than financial market concerns about the forthcoming election, UK bond yields or its Greek-style budget deficit – that may best explain why markets are so aggressively shorting the pound.

The gloomiest explanation for the UK’s recent export performance is that its financial services-focused economy produces little that anyone wants. At the same time, manufacturers that do make desirable goods may be unable to get the credit and skilled workers they need to expand. EngineeringUK, a trade body, believes the country faces a chronic shortage of engineers. Indeed, of the net 2.4m jobs created from 2000 to 2007, Andrew Hunt Economics notes almost all were in non-traded sectors: 1m in finance, 1m in the public sector, and about 750,000 in construction and restaurants. Meanwhile the manufacturing sector lost 1m jobs.

Consider the economy in the round and this puts the incoming government in a tricky situation. The budget deficit – at some point – will need to be cut. Yet interest rates can hardly go any lower and household incomes and consumption are already being squeezed. So where will growth come from?

The numbers are daunting. If the budget gap is to shrink from 13 per cent of gross domestic product to 3 per cent, economist Andrew Smithers points out there will have to be offsetting changes elsewhere equivalent to 10 per cent. One way would be for a 5 percentage point rise in investment and the same in the current account surplus. Sadly, the latter has long been on a declining trend.

Sterling could bounce once election uncertainties lift. But, longer term, while the UK rebuilds its skills gap, the economy may well need not just a weak exchange rate but an ultra-cheap one. Sterling could yet take a bath too.

Post a comment below or e-mail the Lex team confidentially

Get alerts on UK business & economy when a new story is published

Copyright The Financial Times Limited 2019. All rights reserved.
Reuse this content (opens in new window)

Follow the topics in this article