Economy: Currency Fluctuations

Lord Carrington of Fulham Excerpts

Thursday 17th November 2016 Lords Chamber

[Lord Carrington of Fulham (Con)]

My Lords, I bring to the attention of your Lordships my interests as recorded in the register. I add my congratulations to those offered by the noble Lord, Lord Haskel, to my noble friend Lady McIntosh on obtaining this debate and on its timing, coming as it does when our American friends have thrown yet another spanner into the smooth workings of the foreign exchange markets.

With the Trump victory coming on top of Brexit, the various crises in the Middle East, Chinese expansionism, the continuing inability of the eurozone to resolve its problems and sluggishness in the world economy, perhaps it is not surprising that currencies fluctuate—to use the wording of this Motion—although “dance a jig” might be a more accurate description of the state of the markets.

I want to make only two points. First, a fluctuating currency is a hindrance to business and a bar to investment. It may be self-evident, as has been said by my noble friend and the noble Lord, Lord Haskel, that businesses like certainty. Some companies find irresistible the temptation to make opportunistic profits from currency fluctuations, but most would rather remove the downside risk of the currency moving away from them.

It is not just big businesses; small companies often export and have to do so in their customer’s own currency. Sadly, the days when we could insist on exporting in sterling have long gone. Even if companies do not export, they suffer from changes to their input costs caused by the exchange rate, not least those of energy.

However, this has been so for a long time and most businesses cope well with a floating exchange rate. If they are large companies, they can buy forward in the foreign exchange markets and, at a cost, minimise their exchange rate exposure. Small businesses on the whole control their foreign exchange risk by minimising the length of time of their exposure to currency fluctuations where they cannot exercise a hedge.

There are two problems with this. If you are a small company, finding a bank to hedge your currency exposures is near impossible. If you are Muslim and want to operate your business in accordance with the sharia, you cannot simply remove your currency risk. In these turbulent times, would it be sensible if the Treasury were to help small businesses, and Muslim-owned enterprises, to access solutions to such problems at a reasonable cost? Could it be done by getting the banks and the other parties involved to sit down and work out a solution? Perhaps we could get UK Export Finance, which used to be called the Export Credits Guarantee Department or ECGD, involved, because at present it does not really address those problems.

Secondly, there is very little we can do to stop sterling fluctuating. It has been tried before and has met with very little success. The Bretton Woods agreements and the Gold Standard before them led to the UK having an overvalued currency for many years, which was possibly a principal reason for our industrial decline in the decades after World War 2. But there may be quite a lot we can do to smooth the rapid movements in the foreign exchange markets—the fluctuations that so bob up and down rather than the overall general trend.

Decisions in FX trading are made broadly on two criteria. One is mathematical, the other is sentiment. Not much can be done about the maths, but a lot can be done about the sentiment and the guesswork that goes into forming it. I know that the Bank of England and the Treasury do not target sterling exchange rates, and for understandable reasons. It has not been successful in the past—we have just to remember the problems with the ERM. Inevitably, using interest rates to achieve inflation targets also impacts the exchange rate, so forward guidance, whether done in the way the Governor of the Bank of England used to suggest or, as it is now done, by delphic pronouncements from the MPC members, does have an impact on the sterling exchange rate, particularly when taken together with the views of similar oracles at the Federal Reserve and the ECB.

I am sure that great thought goes into the suggestions made as to the future direction of interest rates, but in times of volatile markets, it might be helpful to businesses struggling to make a profit by exporting if some of the interest rate guidance could be given in such a way as to smooth foreign currency market fluctuations. I am not suggesting reverting to targeting the sterling exchange rate, just a more nuanced approach, with the central bank taking some responsibility to smooth the deeply damaging turbulence in the foreign exchange markets caused by excessive volatility.