GO
Loading...

UK Manufacturers Fear 'Downward Spiral' as Pound Tumbles

Pressure continues to mount on sterling as sluggish growth in the country was confirmed in Friday's report on gross domestic product (GDP) - and manufacturers have told CNBC that while they welcome a fall in the currency, a significant fall could be risky.

Paul Sakuma

Growth in the U.K. has once again tipped back into negative territory, according to the Office for National Statistics, with a 0.3 percent fall in the fourth quarter. Output from the mining and manufacturing industries decreased by 1.8 percent quarter-on-quarter.

(Read More: UK GDP Drop Raises Risk of Triple-Dip Recession)

After the news the pound fell to its weakest level in 13 months against the euro and its lowest level in five months versus the dollar.

"Recent slips will be largely positive," according to the Forum of Private Business, a business lobby group.

According to the Manufacturing Institute, a consultancy and training organization, U.K. manufacturers can benefit from the declining pound if they can shift sales from the domestic market to exports.

But a tanking pound can also have a significant negative impact on an already fragile economy.

"There is a real danger that the pound could plunge too far. Broadly speaking, weak currencies create weak economies," a spokesperson for the Manufacturing Institute told CNBC.com.

"A downgrade for the U.K. would cause a downward spiral for U.K. manufacturers - the more the pound weakens, the greater the rate of inflation, the more we start demanding wage increases to afford to pay for goods. So there is a threshold when the pound becomes so weak it is damaging to the U.K. economy."

(Read More: Sterling Takes 'Absolute Pasting' as Troubles Mount)

It's now widely thought that a triple-dip recession is likely while the U.K.'s triple-A rating remains on the brink with ratings agencies Moody's, Standard & Poor's and Fitch all having a negative outlook on its sovereign debt.

"With the existential threat to the euro zone now subsiding, we must admit to growing concerns about the outlook for GBP," Simon Derrick, BNY Mellon's chief currency strategist said in a research note.

"Over time [sterling] has shown that while it can prove extremely stable for long periods of time (as it has increasingly since January 2009), when it does move then the trends can prove substantial and rapid. In short, take care!"

Britain's ruling politicians have been positioning themselves for such a downgrade, according to Derrick, who's noticed a subtle change in their rhetoric.

(Read More: UK's Osborne: Wrong to Abandon Austerity Plan)

Wednesday's confirmation by Prime Minister David Cameron that he favors a referendum on EU membership did little to spur sterling into life. Talk at the World Economic Forum at Davos has also highlighted the potential loss of foreign investment, if the U.K. were to turn its back on its neighbors.

George Osborne, the finance minister, declared in a budget speech in March 2011 that he wanted a "march of the makers" to drive the nation forward. But 2012 was a difficult year for manufacturing, despite a slight uptick in December for the Markit/CIPS Purchasing Manager's Index - a measure of sentiment in the sector. The average PMI reading in the fourth quarter was 49.5, marking a contraction, while the average over 2012 as a whole was 49.2.

(Read More: UK Manufacturing PMI Hits 15-Month High in December)

Jeremy Cook, chief economist at currency broker World First said the Chancellor's plan has "failed spectacularly" despite a central bank that has been trying to weaken the currency.

"A turnaround is no more likely than it ever has been," he told CNBC.com.

Howard Archer, chief U.K. economist at IHS Global Insight told CNBC.com that most manufacturers would probably welcome the weaker pound, at this stage, especially those with major exporting operations.

"Matters are helped by the fact that the pound is weaker against the euro than it is against the dollar. Firstly because, the euro zone is the biggest market for U.K. exporters and secondly because oil and commodities are mainly quoted in dollars, so there will be less of an inflationary impact if the pound holds up better against the dollar."

Analysts agree that the one thing that can save the pound is another flare-up of the euro-zone debt crisis. Which has seen relative calm in recent months as peripheral bond yields have eased.

"I don't expect the pound to really plunge as I suspect that some of the current optimism over the euro zone is overdone, and that sooner or later there will be a reality check. Spain and Italy still have serious problems, while Greece is far from out of the woods," Archer said.

(Read More: Why the UK Jobs Number May Be Misleading)

Despite these fears from manufacturers, the U.K. trade and investment department told CNBC that firms don't typically see any difference in trade with a weaker pound.

Research by the department showed that 70 percent of the firms they surveyed saw no impact on the level of enquiries or orders from offshore clients from a lower rate of sterling.

"There is not a simple link between the value of sterling and the level of exports. Many of our exports are not price sensitive, while others contain significant imported componentry," a spokesperson said.