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Sterling's Value Falls: Energy Bills, Imports And Inflation Will Rise, But It's 'Not Catastrophic'

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STERLING VALUE FALLS
The value of the UK pound has fallen over the past few weeks as traders dump the currency, but is it because our triple AAA rating is at risk? | Alamy

Reports have emerged over the past few weeks that traders are steadily dumping their sterling stocks, slowly devaluing our currency.

When asked for why this is happening, many point to the belief that the UK is on the verge of losing its crucial (at least for chancellor George Osborne) AAA credit rating.

Are we on the verge of losing the top level of rating? And does it matter if we are? The Huffington Post UK spoke to some of the country's leading economists and currency experts to find out if we should be pressing the panic button.

All of HuffPost UK's experts were agreed that there were signs of traders selling out of sterling in the past couple of weeks.

"Sterling has had a sustained period of weakness in 2013 as political posturing from Cameron around the EU budget sparked a trading opportunity," John Greenwood, chief executive of Creechurch Capital explained.

"There is little doubt that faced with a possible triple dip in the UK that the hidden political agenda is to keep sterling as weak as possible against this key trading partner."

And it's not a recent phenomenon; Adad Zangana, European economist at Schroders, said investors moving to underweight positions – when investors hold less of an asset than normal because they expect it to perform badly – in sterling has been happening for the past two months.

Why should we care if sterling has become cheaper?

In short, because it affects inflation – which in turn impacts on how much we spend on our bills, and how far our wages go.

"Selling off sterling, under normal conditions, should be good for the UK economy as it would increase exports and help economic growth and job creation in export industries," said Ismail Ertürk, senior banking lecturer at Manchester Business School.

"But such benefit is not certain because the UK does not have a significant manufacturing industry that can export to the growth markets and, the world economy is not growing at high rates.

"In addition, other countries like Japan intentionally weaken their currencies to export too - so there is a competitive currency deprecation among the high income countries to achieve growth through export."

This situation means imported goods and energy will become more expensive, and the purchasing power of our wallets will reduce.

This phenomenon is often referred to as currency wars in the financial press – where several countries try to devalue their currencies at once to try and appear better value.

"Some people may argue that sterling's collapse is a good thing; however the UK's export market is comparatively small and the declining pound simply imports inflation – making foreign goods more expensive to the consumers and thereby increasing the pain of the average person on the street," explained Glenn Uniacke, head of options at foreign exchange specialists Moneycorp.

World First Foreign Exchange chief economist Jeremy Cook said he was most worried about the increase in inflation.

"Higher inflation, and the disparity between this and the level of wage increases, is what I think is most responsible for the UK's poor start to this year, as demonstrated in Friday's retail sales numbers. Life is just too expensive at the moment."

sterling value falls

Headlines like this will strike again if we sterling keeps depreciating

And Fawad Razaqzada, analyst at GFT Markets, warned our heating bills could go up again – a most unpalatable thought given the big six energy providers have just increased them.

"Heating your home and driving your car will again become more expensive as the value of the pound weakens," he told HuffPost UK.

"The same will apply for other imports and foreign holidays, but on the flip side, it's cheaper for others to buy things made in the UK so exports and employment may get a boost if the depreciation is marked enough."

That said, the expected increase in prices aren't enormous – the difference in sterling against the euro prices swings around 10%, so isn't big enough to see a real difference, according to Creechurch Capital's Greenwood.

And when we look at why these traders are getting itchy trigger fingers, a few reasons emerge.

"The AAA rating fears are part of the story, but the weak fundamentals of UK growth have suggested that sterling should be weaker against most of its main currency competitors. In addition, the reversal of safe haven flows (linked to the Euro crisis) has hurt sterling of late," said Zangana.

"Lastly, recent comments by Mark Carney, incoming governor of the Bank of England, suggest he will be more active in trying to stimulate the economy, which is likely to be through keeping interest rates low, and undertaking more quantitative easing (the process of printing more money to provide liquidity to the markets), which in turn, drives sterling down."

The inflation report from the Bank of England last week was also partly to blame. The Bank now expects inflation to exceed its 2% to 2.3% target two years out, and for growth to remain below its potential until 2015.

"In other words, the Bank of England is prepared to put up with stronger inflation in the context of weaker growth," reasoned Natixis strategist Nordine Naam.

"The slump in January retail sales, down 0.6% when the consensus had been for a 0.5% increase, confirmed the weak growth prospects for the British economy."

So will we lose our AAA rating?

Yes, according to every expert HuffPost UK spoke to.

"It is probable that the UK may lose its AAA rating because the budget deficit is not improving, the economy is not growing and the UK still has very weak banks like RBS and Lloyds Group that rely on government support," said Manchester Business School's Ertürk.

He also said the rating was likely to drop because the Bank of England's quantitative easing policies are not working and because it had built up a portfolio of UK government debt.

The bigger question is does it matter that the UK will lose its AAA rating? Ratings agencies have undoubtedly become more cautious and conservative after the credit crunch and resulting recession – and the downgrades of France and the US saw a flurry of media coverage.

But there has been little significant change in France, and the US is openly challenging its ratings change, so should we be bothered about losing ours?

"We'll see a flurry of headlines - most of these will be alarmist nonsense. We're also likely to see a high-profile government response and then back to business as usual with zero actual impact. Look towards the US for proof of this," predicted Creechurch Capital's Greenwood.

sterling value falls

Does it matter if we lose our triple A credit rating?

"Borrowing costs may come under pressure –when the government wants to borrow money in the open market, the price of doing this may be higher," warned GFT Markets' Razaqzada.

That has to be paid for somehow, so it could be passed on to us in the form of higher taxes or reduced welfare payments.

Looking more widely, some financial institutions such as pension funds will be forced to sell a type of investment called gilts – a kind of government 'I owe you' usually favoured as a strong investment by cautious investors – as their rules will stipulate they can only buy AAA rated gilts.

Other investors will see this as guidance that there has been a deterioration in the UK government's credit worthiness, even if it's only a small one.

But many economists, including Schroders' Zangana believe the markets have already priced in the downgrade, meaning the cost of borrowing won't spike by that much.

Perhaps a bigger concern is the impact the price of government borrowing may have on the wider borrowing market - a downgrade will "hinder UK banks raising capital to get out of the problems they face, and to provide finance to SMEs and private sector" according to Manchester Business School’s Ertürk.

But for the most part, economists are relaxed about a potential downgrade - The UK and other global economies are still deep in the process of moving away from high debt levels, but thankfully it's all happening at the same time.

And as Moneycorp's Glenn Uniacke put it: "An era of low growth while economies restructure is arguably a far better scenario than a deep depression followed by a sharp recovery, as has been seen in the past."

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