Sunday, July 14, 2019
Friendless pound needs the kindness of strangers
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt.

Even before Sir Richard Branson offered his opinion on the pound, I was intending to write about sterling this week. This is a time of year when many people think about the exchange rate more than at other times and encounter the reality that businesses and the markets have been dealing with for the past three years. The pound, unsurprisingly in the light of the current uncertainty, has taken on a weaker tone recently.

Branson thinks sterling will go to one-for-one parity with the dollar in the event of a no-deal Brexit this autumn, from $1.25 now, and, while that is a touch below market expectations, it is in the right ballpark. With the euro worth almost 90p, equivalent to a euro-sterling rate of €1.11, the pound would be headed below parity with the single currency, embarrassingly.

Already, for tourists, even current very low market exchange rates are an unattainable dream. Those leaving it late and changing currencies at the airport have already experienced the reality of a sub-parity euro. Staycationing has its merits.

Sterling has been the Brexit barometer over the past three years. Even knowing that, I found it hard to believe, as has been claimed, that the pound’s fall on the referendum result in June 2016 was the sharpest for any major currency in the floating rate era, which extends back to the early 1970s. Surely there have been bigger sterling falls, not least when the pound tumbled out of the European exchange rate mechanism (ERM) in September 1992.

It is, however, true. The sterling index, which measures the pound’s average value against other currencies, fell by 9.2% in the 48 hours after the referendum, and by 11.4% over two weeks. That compares with 5.7% and 8.6% respectively when sterling crashed out of the ERM. The pound had a bigger cumulative fall over 2007-8, during the financial crisis, falling by more than 25% in total. But what was a drawn-out affair and was followed, as is typical, by a recovery. Currencies tend to overshoot.

This time, however, there has been no recovery. Sterling is lower now than it was in the early days after the referendum, against both the dollar and the euro. A measure of how weak the pound has been over the past three years is its average value against the dollar, $1.30, compares with $1.65 over the 10 years leading up to the summer of 2016, and $1,66 in the 30 years leading up to it.

Sterling’s recent fall was halted briefly last week by testimony from the Federal Reserve Board chairman Jerome “Jay” Powell, pointing to an early cut in US interest rates, and by the release of monthly gross domestic product (GDP) figures in the middle of last week. It is worth briefly reflecting on them. The 0.3% rise in monthly GDP in May, reported by the Office for National Statistics (ONS) was in line with the consensus, and represented a partial bounce from the 0.4% drop recorded in April. Car factories had shut down in April as a result of the original March 29 Brexit deadline and restarted again.

The figures also showed a 0.3% rise in GDP for the March-May period compared with the previous three months, which was better than expected, but was entirely the product of data revisions. The nerdy explanation is that the ONS revised down February’s monthly GDP slightly, shifting it into March. That made March-May better but the question for the second quarter as a whole remains. If June was as gloomy as the purchasing managers’ surveys suggested, there will be a small fall in GDP in the quarter. If not, it will be flat, or there will be a tiny rise. Whichever way, growth has slowed significantly, though it is too early to say whether that has continued into the third quarter.

Some people, of course, welcome a weak pound. John Mills, the founder of JML, the Labour donor and prominent Brexit supporter, is a tireless campaigner for a permanently low level for sterling.

If devaluation was the road to riches, though, we would be all as rich as Croesus. Sterling’s fall is now mature enough to suggest that we should now be on the upslope of what economists call the J-curve; devaluation initially produces a trade deterioration because imports are more expensive, followed by a later improvement because of improved export competitiveness.

It is not, however, happening. Britain’s trade deficit in goods widened by £15.7bn to a huge £153.5bn in the 12 months to May. There have been some distortions in the figures this year but the underlying picture is one of deterioration, not improvement.

This is where it becomes concerning. The worsening of Britain’s trade deficit in goods is only one aspect of this country’s balance of payments problem. In its Financial Stability Report, published on Thursday, the Bank of England highlighted this vulnerability.

As it put it: “A current account deficit indicates that national investment is larger than national saving, and therefore must be financed by net borrowing from overseas. The UK’s deficit widened to 5.6% of GDP in 2019 Q1. This is large by international standards. Since 2016, the UK has relied on substantial gross capital inflows from foreign investors to fund its current account deficit.”

The UK. It added, is “vulnerable to a reduction in foreign investor appetite for UK assets, which could lead to a tightening in credit conditions for UK households and businesses”. Britain, to draw on an earlier phrase used by Mark Carney, is dependent on the kindness of strangers or, at least, a low enough exchange rate to make UK assets cheap enough for foreigners to want to buy. A high proportion of those flows have been into commercial property.

The Bank thinks sterling would be riding for a fall in what it describes as a disorderly Brexit. Under that, it says, sterling along with a range of UK assets “would be expected to adjust sharply”, its euphemism for fall out of bed. The pound would probably not fall as much as the 27% the Bank has allowed for in its famous, or infamous, stress tests for the banks.

Can sterling regain its poise, if not for this year’s summer holidays, perhaps next year? The pound has few friends at the moment, probably because of the political situation. Adam Cole, chief currency strategist at RBC (Royal Bank of Canada) Capital Markets agrees that no-deal would produce a big fall for the pound but even exit with a deal would not have much of a sterling upside, because markets would still fear other political developments, including a general election. The only meaningful upside for the pound, he suggests, would be if Britain reversed its decision to leave the EU. Anything is possible, but that looks unlikely.