Since the financial crisis struck in 2008 and the public finances unravelled, Britain has had just two weapons in its armoury to fend off recession: low interest rates and the weak pound.
Low rates were supposed to ease the debt burden on households and pump cheap credit into businesses, while the weak pound delivered a competitive boost for exporters.
Half the economic artillery, though, has started to fire blanks. The pound is not quite so weak any longer.
In the past seven months, sterling has strengthened by 5pc against the euro. At €1.2761, it is back at levels not seen since mid-2008 just before its collapse to near parity with the euro.
As the euro crisis has deepened , the pound has strengthened. In the past three-and-a-half years, sterling has gained 25pc against the single currency.
What’s good for holidaymakers, though, is not so good for Britain’s exporters. “It’s clearly not helping,” Simon Hayes, UK economist at Barclays Capital, said. “If it is sustained, it will be another significant headwind to the recovery.”
Although the pound has more or less held its 20pc fall against the dollar, the euro exchange rate is arguably the one that really matters. Some 45pc of UK goods exports go to the single currency bloc compared with just 13.9pc to the US, according to the Office for National Statistics (ONS).
At the EEF, the manufacturers organisation, theory is already being backed by anecdote. “We have been getting feedback from some sectors that the strength of the pound is getting extremely unhelpful from an export point of view,” Lee Hopley, the EEF’s chief economist said.
The early rumblings of trouble will not rest easily with the Chancellor, who has pinned his hopes on an export-led recovery delivering his vision of “a Britain carried aloft by the march of the makers”.
It is also beginning to make Sir Mervyn King, the Governor of the Bank of England and a leading advocate of the strategy, squirm. Asked in May if he was worried about the rise of sterling, he chose to duck the question. “I don’t think central bank governors can ever expect the exchange rate to move exactly as they would wish,” he said.
According to currency experts, one of the reasons the pound is being targeted is because safe haven investors are running out of affordable targets.
The Swiss franc is being defended desperately from over-appreciation by the Swiss National Bank and Scandinavian currencies are looking “fully valued”. The pound, though is still about 6pc below its pre-crisis high against euro of around €1.35.
So how much of a threat does sterling’s appreciation actually pose? Surprisingly, economists are fairly sanguine.
They don’t quite say it, but it’s clear they believe the authorities overstated the stimulative effect of depreciation. Ross Walker at Royal Bank of Scotland said: “The strength of demand is more important than exchange rates. It shouldn’t pose a major headache for UK exporters particularly at the high value end.”
Ms Hopley added that the pound’s move is only really hurting the UK’s basic metal and commodity exporters. “As one of our members said to me, if you are a strategic supplier into high-end German car manu-facturing, what matters is how many cars they sell. Not the value of sterling,” she said.
In other words, the real headwind is proving to be the collapse in demand in the eurozone. Since the euro’s problems began in earnest in early 2010, the trade deficit in goods has been gradually rising.
Although, manufacturers are exporting more, imports have risen even faster. In the first quarter of 2012, the deficit was £25bn £3bn to £5bn higher than before the crisis.
To compensate for the drop in eurozone demand, exporters have been busy moving into new export markets, Ms Hopley said. The value of UK exports to Brazil, Russia, India, and China has risen from 3.9pc of the total in 2005 to 8.1pc now. The eurozone’s share of UK exports by contrast has fallen from 52pc to 45.3pc.
In May, for the first time in decades, Europe (Chicago Options: ^REURUSD - news) as a whole accounted for less than half of all UK exports. As most business with emerging markets is priced in dollars, Britain’s exporters are shielding themselves from currency appreciation as well as finding more reliable sources of demand.
While export volumes may have failed to pick up significantly, what sterling’s collapse did achieve was to make UK companies more profitable. Every dollar or euro earned translated into more pounds than before. For companies contending with high commodity prices, the windfall was a godsend boosting margins with no extra effort.
For euro exporters, that effect has now been unwound. Restoring confidence in the eurozone would be the biggest boost, Ms Hopley said.