5. Impact of recent sterling depreciation on manufacturers’ imported inputs and export prices

Between November 2015 and October 2016 the value of sterling fell sharply. Over the same period, import and export prices for the UK manufacturing sector rose. Figure 1 shows the input Producer Price Index (PPI) for imported materials and fuels (Imported Inputs), Export Price Index (EPI) and the sterling effective Exchange Rate Index (ERI), which measures changes in the strength of sterling relative to a basket of other currencies. Between November 2015 and October 2016, the sterling effective exchange rate fell, which is associated with an increase in import and export prices when reported in sterling terms.

Figure 1: Imported Inputs, EPI and the Sterling Effective Exchange rate Index (ERI) Source: Office for National Statistics, Bank of England Notes: Series are not seasonally adjusted. The sterling effective change rate measures changes in the strength of sterling relative to a basket of other currencies. The sterling effective exchange rate is only indicative of the rates applied to producer prices. This is because the sterling effective exchange rate is a trade weighted index that represents all UK trade, whereas producer prices reflect transactions in the manufacturing sector. Download this chart Figure 1: Imported Inputs, EPI and the Sterling Effective Exchange rate Index (ERI) Image .csv .xls

Figure 2 shows the 3-month year-on-year rolling average growth rate for the price of imported inputs, EPI and the sterling effective exchange rate. Between November 2015 and November 2016, the sterling effective exchange rate fell from 5.7% growth to a decline of 16.9%, implying a sharp fall in the value of sterling. This period coincided with the EU referendum vote, which resulted in a month-on-month fall in ERI of 6.5% between June and July 2016, which was the largest movement in the monthly rate since November 2008. Between January and June 2017, the sterling effective rate has stabilised (Figure 1), while the 3-month year-on-year rolling average comparison has moved in an upward direction due to 2016 movements falling from the annualised figures.

Figure 2: Growth of Imported inputs, EPI and the Sterling Effective Exchange rate (ERI), 3 months-on-same 3 months a year ago rolling average Source: Office for National Statistics, Bank of England Notes: Series are not seasonally adjusted. The sterling effective change rate measures changes in the strength of sterling relative to a basket of other currencies. The sterling effective exchange rate is only indicative of the rates applied to producer prices. This is because the sterling effective exchange rate is a trade weighted index that represents all UK trade, whereas producer prices reflect transactions in the manufacturing sector. Download this chart Figure 2: Growth of Imported inputs, EPI and the Sterling Effective Exchange rate (ERI), 3 months-on-same 3 months a year ago rolling average Image .csv .xls

The impact of the depreciation on UK manufacturing prices was twofold; input costs associated with raw materials and fuel prices increased, while output prices for exported goods rose in sterling terms.

Between November 2015 and June 2017, which spanned the depreciation, growth for prices of imported inputs ranged from a decline of 13.2% to an increase of 18.9% in February 2017 (Figure 2). All else equal, a fall in the value of sterling will lead to higher costs associated with imported inputs.

The depreciation of sterling was not the only upward pressure on input prices across the period, however, as international commodity prices also recovered following two years of falling prices. The sector has also experienced domestic cost pressures. Over the past two years unit labour costs for manufacturers have grown at a faster pace than domestic output prices; for further analyses on unit labour costs see section 6 of July's Prices economic commentary.

In addition to rising costs, the depreciation has also presented some manufacturers with an opportunity, as when a currency falls in value exporters have two extreme options. They can leave their prices unchanged in foreign currency terms and capitalise from higher prices once currency is exchanged into sterling. Alternatively they can drop their prices in the importing country by the full change in the exchange rate (keeping the sterling price the same) to become more competitive internationally with the aim of increasing their sales volume. There is also a case between these extremes where some of the competitive gains from the currency depreciation could be shared between the exporting manufacturer and the importing country. This latter situation is more likely when the importing country is more price sensitive, and where there are home-produced alternatives to the imported British goods.

According to EPI, export prices for UK manufactured goods increased in sterling terms following the depreciation from November 2015 (Figure 2), suggestive that UK firms did not immediately drop the price of their goods in foreign currency terms.

At their peak in December 2016, export prices increased 12.7% year-on-year on a rolling 3-month average basis (Figure 2), while the sterling effective exchange rate fell 16.9%. Since the beginning of 2017, growth in export prices has slowed (Figure 2).

The upward impact on export prices can also be seen in export turnover sales. By construction, prices multiplied by quantity give turnover:

All else equal, if export prices in the manufacturing sector rise (in sterling terms, but not necessarily in foreign currency terms), turnover for firms will also rise. If the foreign currency price were also to rise, provided the demand (quantity) response away from the British good was not too strong (that is, the export was relatively price inelastic), turnover in sterling terms could also be expected to rise.

Figure 3 shows export turnover sales growth for the manufacturing sector as reported by the Monthly Business Survey (MBS), along with export price growth reported by EPI. Between June 2016 and June 2017, export turnover rose by an average 9.7%, while export prices rose by an average 8.6%. Following the depreciation, export turnover growth peaked at 19.1% in January 2017 when looking at a 3-month year-on-year rolling average basis, while export prices peaked at 12.7% in the 3 months to December 2016 on the same basis.

Some UK manufacturers are therefore assumed to have benefited from the recent depreciation by realising higher prices in sterling terms and therefore turnover, for exported goods; however, what is not clear from these analyses is the degree to which higher input costs for imported raw materials and fuels, also a result of the depreciation, have offset any potential gains generated from exports.