EU Officials Concerned About Risks of Pound Drop

By Meera Louis

Feb. 25 (Bloomberg) -- European Union officials are concerned that the pound’s slide to a record low against the euro could destabilize the British economy, according to a document prepared last month by European Commission and EU finance ministry officials.

The pound’s “very rapid” drop “raises questions about the financial stability of the British economy,” said the document, which was prepared ahead of the Feb. 14 Group of Seven meeting in Rome and obtained by Bloomberg News. The currency’s weakness “is a source of concern for the euro area.”

The report contradicts Prime Minister Gordon Brown’s argument on Feb. 13 that a weaker currency helps rather than hinders the economy. With the pound down 18 percent against the euro in the past year, it also underscores investors’ concern about Britain’s fiscal health as the government racks up debt to fund bank bailouts.

The one-page document, titled “Recent exchange rate developments - G7 preparation,” was circulated at a meeting of EU officials before the G-7 gathering in Rome. The document also outlined the EU’s position on the U.S. dollar, the yuan and the yen before discussing the pound.

The Obama administration’s expressed support for a “strong dollar” is “reassuring,” the document says. It also calls for a “continued real effective appreciation” of the yuan against the euro. Japanese authorities “should not intervene to reverse the past appreciation of the yen,” it says.

Pound’s Slump

The document signals concern among euro-area policy makers that the pound’s slump could push their 16-nation economy deeper into a recession by undermining exports to its biggest trading partner.

Gross domestic product in Britain contracted 1.5 percent in the fourth quarter, the most since 1980, as companies and consumers reduced spending, the Office for National Statistics said today. The economy shrank 1.9 percent on the year.

A U.K. Treasury official who declined to be named said the government doesn’t comment on movements in currency markets.

Policy makers “should be alive to the possibility that weakness in the pound will just scare off foreign investors,” Neil Mackinnon, chief economist at ECU Plc in London and a former U.K. Treasury official, said in an interview on Bloomberg Television today. “The U.K. economy is certainly in a recession if not a mini depression.”

The U.K. currency fell 23 percent against the euro last year as confidence in Britain’s fiscal health weakened, export demand dried up and Bank of England cut interest rates to records. The pound reached a record low of 98 pence per euro in late December. It traded at 88.87 pence per euro at 12:12 p.m. in London.

‘More Competitive’

“As the pound has gone down, we’re more competitive,” Brown said Feb. 13. “We’re not trying to target the exchange rate like people used to do.”

At the same time, his government has taken on liabilities that may amount to 1.5 trillion pounds ($2.2 trillion) as it tries to prop up the financial system and rescue banks such as Lloyds Banking Group Plc and Royal Bank of Scotland Group Plc.

Nigel Lawson, the longest serving chancellor of the exchequer under Margaret Thatcher, said yesterday the U.K. government may have to introduce “a short period of nationalization” for some banks.

Europe’s officials are concerned that global currency volatility could roil markets and destabilize their economies.

“Exceptionally high volatility and unprecedented sharp moves in the foreign-exchange market have adverse implications for economic and financial stability and are especially unwelcome in the current economic environment,” the draft document said. “In a context of low inflation in all major economies, any large moves will translate into big real exchange rate swings that could lead to competitive distortions.”

French and Irish finance ministers have already openly questioned the U.K.’s management of its currency.

France’s Christine Lagarde said Jan. 21 that the Bank of England’s monetary policy “isn’t very efficient in providing more support” for the pound. Ireland’s Brian Lenihan said that Britain is engaging in “competitive devaluation.”

To contact the reporter on this story: Meera Louis in Brussels at mlouis1@bloomberg.net