19 December 2017

Sterling Undervaluation Remains Modest

  • Sterling only 1.1% undervalued as deal struck to for UK / EU to move onto trade talks
  • UK Consumer Price Index expected to ease in December
  • Euro 4% overvalued as Brexit talks move on to trade but large disparities remain

The Strength of the UK Pound
Many economists agreed that sterling was overvalued for a number of years prior to the referendum in the summer of 2016. Where there were disagreements, they centred on the magnitude of the overvaluation in relation to the currencies of major trading partners in particular the US dollar and the Euro. There has also been some debate of the extent to which the UK’s current account deficit on visible trade will be responsive to a lower value for sterling.

The uncertainty since the referendum, the decision to trigger Article 50 and a hung parliament following Theresa May’s botched election have all had negative effects on the sterling dollar exchange rate, but the fundamental value of sterling is not significantly undervalued against the dollar. In Purchasing Power Parity (PPP) terms, for example, sterling as measured by December’s World Price Index (WPI) is only 1.1% undervalued against the dollar compared with an undervaluation of 10% a year ago.


Euro Strains Remain
Decembers WPI data also shows that in PPP terms, sterling remains more competitive in terms of the US dollar than the Euro, with an overvaluation of 4%. This is based on a weighted average of a sample basket of goods across the largest four Eurozone countries and Greece. The PPP methodology shows that with an undervaluation of 8% against the US dollar, German exports are still more price competitive than those of the UK. In contrast, a French Euro was overvalued by 17% in December, up from 6% in the same month last year. This difference between France and Germany shows the scale of the task facing country leaders.


Inflationary Pressures Continue
There is some evidence that the undervaluation of sterling in PPP terms is starting to benefit manufacturing exporters, but its main impact on imports is to push up inflation. The chart overleaf shows that monthly WPI price data can be used to measure the value of sterling which moves fairly closely in line with the Consumer Price Index (CPI) in the UK. The CPI has been rising steadily since the EU Referendum but the rate of growth to October largely stabilised while WPI data for November and December data is showing a slightly cooling trend.

Major currency disparities in Purchasing Power Parity terms are shown in the chart below.


About the World Price Index
The World Price Index (WPI) measures the value of an urban selection of goods and services at purchasing power parity (PPP), reflecting the real purchasing power of different nations, allowing for rapid and accurate international price comparisons. Under/Over valuation data is based on the difference between the exchange rate value of a currency and that of the US Dollar in relation to the World Price Index calculated exchange rate. Based on WPI global data the degree of currency under or over valuation in PPP terms by country is provided in the chart below.





 







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Notes to Editors
  • The World Price Index is based on original data collected by World Economics.
  • The World Price Index is released during the 4th Working week of each month.
  • Latest month market exchange rates are calculated at the time of data collection.


About The World Price Index

The World Price Index is calculated monthly from a basket of internationally comparable goods and services. It is designed to alleviate the horrendous problems associated with analysing economic or market data using currency market exchange rates.

Exchange rates vary with extraordinary rapidity, frequently with little obvious link to economic reality, but fatally distorting the perception of value in markets and economies. It is vital when analysing international data, whether for market analysis purposes, or to allocate resources across the globe, to review data using an international yardstick of value. This can only be done using Puchasing Power Parities (PPP), which make allowance for the purchasing power of currencies within individual countries to make comparisons based on a standard currency, usually "international dollars".

There are various sources of PPP data, but most are of only academic interest as they are years out of date. The World Price Index is the only available index updated monthly to provide an easy way of reviewing trends or relative values of market or economic data in realistic terms.


About World Economics
World Economics is an organisation dedicated to producing analysis, insight and data relating to questions of importance in understanding the world economy. Its parent company Information Sciences Ltd has a long history of the development of key business information today used throughout the world, including the origination of the Purchasing Managers Indexes in Europe and Asia (now owned by Markit), and the development of WARC a global information provider for major corporations .

Currently our primary research objective is to encourage and assist the development of better and faster measures of economic activity. In cases where we believe we can contribute directly, as opposed to through highlighting the work of others, we are producing our own measures of economic activity.

Our work is mainly of interest to investors, organisations and individuals in the financial sector and to significant corporations with global operations, as well as governments and academic economists.

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