Economic woe hurts sterling
The POUND’S long-run sustainable exchange rate may have fallen due to an increased focus on Britain’s economic imbalances in the wake of the credit crisis, the Bank of England (BoE) says in a report published today.
In an article in its Quarterly Bulletin, the BoE says changes to Britain’s relative economic outlook, the perceived riskiness of UK assets and the need for the economy to rebalance away from domestic consumption all played a role in sterling’s fall over the past two years.
While some factors behind the decline may be temporary, others could be long-lasting, it says.
Since the mid-1990s Britain has consistently run current account deficits averaging around two per cent of GDP, a situation that was sustainable as long as the deficit was offset by foreign investors’ purchases of UK financial assets.
“But the financial crisis may have led overseas investors to reassess their willingness or ability to purchase sterling assets and thereby finance the UK trade deficit,” the BoE article notes. “As a result, the long-run sustainable real sterling exchange rate, the rate consistent with a balance of UK real aggregate demand and supply and a sustainable external net asset position, may have fallen.”