Is the tumbling pound providing a correction, or are we losers now?
A strong currency can be a sign of a country’s economic success. When a currency rises against another, those earning income in it have greater spending power. Equally, a weaker currency is considered by some to be a source of national embarrassment.
Last week’s sterling crash was rather embarrassing for Britain – the pound fell 4.2 per cent last week and Friday’s flash crash stole headlines across the world over the weekend thanks to hedged positions. But a weaker pound is not necessarily a bad thing, and the strength of Britain’s currency has weighed on the competitiveness of its exports for the last 20 years.
Since Brexit, UK exporters have been given a boost. At 5.9 per cent, the UK’s current account deficit is at one of the highest levels since the war, and manufacturing and services PMI indices for September show an increase in demand from countries able to pick up British bargains.
UK exports have struggled in recent years precisely because strong capital inflows have kept it overvalued for some time. Charles Dumas, chief economist at Lombard Street Research, blames the euro.
Weak growth in the euro area prompted capital flight to sterling at a time when the rush of cash was already pretty strong from China, Russia and the Middle East. “This pushed sterling up and held it at a pretty high level, adding to the difficulties of UK exporters who were facing weak demand from the Eurozone itself,” he says. As China has emerged as an exporting behemoth, and Eurozone demand has remained beneath pre-crisis levels, it has been a difficult time for UK exporters.
Read more: Here we go again: Sterling drops against the dollar
“The jolt has been a necessary corrective,” says Chris Beauchamp, head of market analysis at IG Group. FTSE-listed companies, which earn the bulk of their revenues overseas, certainly haven’t been complaining. The large cap index has risen 10 per cent since the referendum as foreign investors take advantage of cheaper relative share prices for companies with strong corporate earnings.
But there are downsides to a stronger pound. Brexit may quickly achieve what QE couldn’t – price inflation. This could cause real wages to fall and the rate of domestic consumption to fall with them. The yield on 10-year gilts rose to 1 per cent yesterday as foreign investors have been dumping bonds, pushing up government borrowing costs. And as a net importer of (dollar-denominated) oil, UK consumers will feel likely feel the price rally at the pumps. And this is before considering the impact of higher barriers to trade which Brexit may bring, and the fact that trade in goods is worth far less to the UK economy than services.
Both Dumas and Beauchamp see sterling’s fall as having a rebalancing effect for the British economy. Unfortunately for the City, as the recipient of capital inflows and a beneficiary of sterling’s strength, this is likely to come at the expense of the financial sector.