Sterling’s slide revives Euro debate

The plummeting pound is reviving the debate about whether Britain was right not to join the euro when it was launched in 1999 (then it was an electronic currency; the notes did not appear until January 1, 2002). For wine and spirit importers, the debate has become acute. Many are facing minimum 20% price rises in the New Year from their European suppliers.

On the euro’s launch the pound bought €1.68; 12 months ago it stood at €1.42 and by January 1 it had fallen to €1.37. After Wednesday’s doom-laden report from the Bank of England, sterling slumped to €1.195. Some economists now predict that it will fall even further, perhaps to as low as €1.15 by January. That would represent a 15% fall this year and a massive 31% drop since the single currency was introduced.

Those who cherish keeping sterling argue that the rising euro is a function of the European economy growing more quickly than the UK’s, notably because of the accession of the newer Eastern European members of the EU. The history of the euro against the world’s major reserve currency, the dollar, suggests otherwise.

At the start of this year, most traders and economists viewed the dollar as significantly undervalued. This theme was echoed by major exporters to the US, not least Pernod Ricard and Diageo. On January 1, a euro bought 68 cents; today it buys 80 cents. That represents a 17% appreciation of the dollar. By contrast, sterling has fallen so far this year by 27% from $2.05 to $1.49. But when the euro was launched it bought 95 cents, so in six years the euro has depreciated against the greenback by almost 16%. On that basis the evidence points not to euro strength but to sterling weakness.

Many wine and spirit importers agree an exchange rate for a year with their Continental suppliers. Assuming they had agreed  €1.38/37 for 2008, somebody (either the producer or the importer) is taking a 14% loss just on the exchange rate on shipments being made today. So what rate is sensible for next year? Given the Bank of England’s grim prediction of a worse recession than in the early 1990s, today’s €1.19 looks very optimistic. 

Add to the 14% fall in the value of sterling against the euro the 5% or so inflation costs being borne by European producers plus the ratchet effect of VAT and a minimum 20% rise in wholesale prices on UK shipments is needed for Continental suppliers to be in the same position as they were at this time last year. And that presupposes that the Chancellor does nothing to add to the damage in his Pre-Budget report later this month.

Privately importers admit to volumes declining steadily this year, so a 20% price rise will merely accelerate the downtrend, with retailers (not least the supermarkets) demanding lower prices as consumer spending slows. Mervyn King’s prediction of “very difficult times” in 2009 looks like a massive understatement. Euro membership would have prevented some of the now inevitable further pain.