Why the pound should be weaker

Professor Spencer believes the recession is spreading

Professor Peter Spencer, an economic adviser to Ernst & Young's Item Club, argues that the Bank of England is well placed to weaken the pound.

In a controversial report on Monday, the Item Club, an economic think-tank, called for the Bank of England to sell the pound on the currency markets and buy the euro, reducing the gap between the two.

The recession is spreading

Professor Spencer
Item Club

The strength of the pound against the euro has made British goods relatively expensive and left UK manufacturers struggling to compete in Europe.

Professor Spencer believes that the strong pound could spark a recession in the UK as the downturn in the manufacturing industry contaminates other parts of the economy.

"The recession is spreading from [manufacturing and exports] into the rest of the economy," he told BBC Breakfast News on Monday morning.

"[It has spread] first of all into services and secondly into company spending generally, and if we don't watch out, if the pound stays high, those company spending managers will move on from spending to headcount and of course at that point consumer spending goes too."

Intervention woes

In the past, intervention by the Bank of England has not always been successful, such as during the Exchange Rate Mechanism (ERM) crisis of 1992.

The UK was forced to abandon the ERM, which dictated an upper and lower limit on either side of a central exchange rate, following a run on the pound.

If you are selling your own currency, you can print as much of that currency... as you really like, and that is respected in foreign exchange markets

Professor Spencer
Item Club

Often such intervention by central banks is risky because currency traders collectively have more power in the markets.

With the ERM, the UK had entered the pound at what turned out to be too high a rate and spent vast sums of Treasury reserves defending sterling's value against bearish traders.

But Professor Spencer says it is a different story this time because the Bank of England would be selling the pound instead of buying it.

"If you are actually buying your own currency to support it as we did in the ERM, for example, it's very difficult because there is only a certain amount available," he explained.

"[But] if you are selling your own currency, you can print as much of that currency, you can print as many pounds, as you really like, and that is respected in foreign exchange markets."

The 'root cause'

Professor Spencer identifies the "root cause" of the UK's slowdown as a "general increase in competitive pressure in the British economy".

He explained that companies have been forced to cut prices because of the strong pound and the advent of the internet, which makes prices more transparent.

"All of these things have come together to take pricing power away from companies and that's left companies very short of cash," he said.