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A Strong Sterling -- And No Complaints


The euro is up against the dollar -- way up. And that's hurting European exports. So euro-zone officials are pushing Washington to take action to bolster the greenback, including reducing its current account deficit. But there's another European currency that has been taking off, too. The British pound rose to almost $2 in early December, its highest level in 12 years, before slipping a bit to its current $1.94. All told, the pound has advanced over 20% against the greenback since late 2002. But are the Brits squawking? Not very loudly. In fact, overall, the British like their currency strong.

How so? For starters, the British economy is a lot more flexible and robust than its Continental counterparts, so it can more easily handle an appreciating currency. British growth is expected to hit 3.3% this year, and, though it's now slowing, it's projected to reach a still-respectable 3.1% in 2005. That growth has been driven by rising consumption that is directly linked to the strong pound, which makes cheap goods from Asia ever cheaper. In the three months through October, retail sales jumped 6.6% over the same period last year. An analysis by Goldman Sachs & Co.'s London office finds that in the past five years apparel prices in Britain have plummeted by a third as retailers such as Asda, owned by Wal-Mart Stores Inc. (WMT), boosted their production in Asia, where currencies are pegged to the dollar.

Britain's comfort with its strong pound stands in marked contrast with the last time it rose so high. That was back in 1992, when the government fought speculators such as George Soros, who were betting against the viability of the pound in Europe's Exchange Rate Mechanism. After trying to prop up the pound with interest-rate hikes, Britain finally had to remove itself from the ERM, essentially devaluing the currency. "Even though sterling is back up at those levels, it's a very different world now," says Rizwan Din, foreign exchange analyst at Barclays Capital Inc. in London.

SERVICE ADVANTAGE

What's different? Britain's manufacturing sector, already in decline in 1992, now accounts for only 18% of the economy, which today survives and thrives largely on services. This change hasn't been lost on the Bank of England. In late November, BOE chief economist Charles R. Bean noted in a speech that the economy is not only benefiting from low-cost Asian manufacturing but, because of the high pound, it's also making more money selling services such as consulting, accounting, and insurance brokerage overseas. Thus, said Bean, "the evolving pattern of global comparative advantage has been particularly favorable" to Britain.

While it exports pricey services, Britain is importing capital since the rising pound is a magnet for global bond investors. That makes it easier for the government to fund its budget gap, which has risen to nearly 3% of Britain's gross domestic product in the bond markets in the next year. "A strengthening currency will make the negative impact of the deficit less harsh," says Robert N. Stein, a managing director at Astor Asset Management LLC in Chicago.

Sterling's strength doesn't please everyone. In mid-November, Joe Greenwell, chairman and CEO of beleaguered Ford Motor Co. (F) subsidiary Jaguar, which makes Jaguars and Land Rovers in Britain and sells most of them in the U.S., told the House of Commons that exchange rate pressures have had a "very significant" impact on his profits this year. British Big Pharma is also hurting.

But the impact of a high pound on what's left of domestic manufacturing is muted since Britain's main export market is the rest of Europe, where it has not gained ground on the euro. So, Germany and France, complain all you want. Europe's other strong currency isn't inflicting much pain at all.

By Laura Cohn in London


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