Brexit: If the pound weakens, is it such a bad thing?
Sterling has been swinging as the threat of a potential British exit from the EU looms large. The pound has fallen by eight per cent against the dollar in the last year. It reached a two- and-a-half year low in April, as international investors sold out of sterling assets. The pound then rose last week as polls showed the Bremain campaign had taken a lead and a leave vote seemed less likely.
The volatility has been unnerving, and it may continue. Bank of England governor Mark Carney has said the pound could fall, “perhaps sharply” if Britain votes to leave.
A weaker pound has a variety of consequences. It can raise the cost of imports, which can mean higher prices overall, and that has the knock-on effect of raising inflation. Going on holiday would be more expensive for Britons too.
But not everyone is convinced a weaker pound would mean bad news for the UK. One factor is that strong sterling makes exports less competitive on the world market, because overseas buyers need more of their currency to buy them.
“There are two sides to every coin. There probably would be a weaker pound in the event of a Brexit vote but that is not such a bad thing,” argues Jason Hollands, managing director of Tilney Bestinvest.
Central banks around the world from the Eurozone to China and Japan are all trying to devalue their currencies. It’s a competitive game dubbed “currency wars” by economists, as each country has been hindered by its currency’s strength. Weakening the yen, yuan or euro in relation to their neighbours should give a boost to local manufacturers. This has been going on for years, and has been hotting up recently.
Perhaps the UK could join too, with a weaker pound in a post-Brexit world.
“Even if we don’t get a free trade deal to lower tariffs on trade with the world, a weaker pound would offset that and make our exports attractive,” Hollands says. “Japan doesn’t have a free trade deal with the EU, but where did your TV come from?”
As for inflation, the Bank of England has a two per cent target. Consumer price inflation has been barely above zero and fell to 0.3 per cent in April. “Low inflation is good for shoppers, but for every winning consumer there is a losing business. Businesses lost out on £4.6bn in the first quarter due to lower than targeted inflation,” says Mark Billige,managing partner at Simon-Kucher & Partners.
The FTSE 100 is home to the UK’s biggest companies but the bulk of their profits come from overseas. When earnings are translated back into a weaker pound, they would seem higher.
Dividends from these companies could also be raised. “In the event of a leave vote, a sharp fall in sterling could largely offset any deterioration in sentiment [towards the FTSE 100],” according to analysis from Capital Economics.
One fund manager said a post-Brexit fall in sterling would mean an attractive opportunity for investing in the UK. Property would also be cheaper for wealthy international buyers – and there have been signs demand at the higher end of the market has been cooling lately, perhaps because of Brexit worries.
Independently, each of these arguments do make sense, but “the problem is when you try and aggregate them all together,” says economist Simon French of Panmure Gordon. “Overall, weaker sterling would slow growth,” he explains, as it raises the cost of everything from energy to clothing and that hurts both people and business.
Historically, a stronger currency is also correlated with a robust economy, judging by GDP growth.
“If you look at the strongest the pound has been, when it traded above £2/$1 before the financial crisis… it was driving huge GDP growth,” explains French.
A similar effect has been seen in the US in recent years. As data shows the American economy is one of the strongest in the world, and able to withstand higher interest rates, the dollar has risen considerably.
A weaker pound may not cause catastrophe, but it’s unlikely to be a golden bullet either.