Sterling on the Skids

Sterling has fallen to levels not seen since the mid–1980s when Margaret Thatcher waged her crusade against the trade unions.

The unions are now no more, but the UK faces similar challenging political and economic headwinds following the 23 June 2016 referendum result in favour of leaving the EU. This has weighed considerably on the GBP, which has lost over 11% against the USD, the EUR and the CHF. Cable or GBP/USD has slipped below 1.3000, but the currency remains above its three-decade low of 1.2796.

The UK’s uncertain political and economic picture looks set to continue which could place even more downward pressure on Sterling. It remains uncertain what form and route UK negotiations with the EU will take. In particular, whether and when Article 50 of the Treaty of Lisbon, which sets out how a member state can voluntarily leave the EU, is triggered remains unclear.

Bank of England Governor Mark Carney has repeatedly warned that there is a prospect of a slowdown in the UK economy post-Brexit. As a pre-emptive countermeasure Mr Carney hopped on Ben Bernanke’s helicopter, borrowed Mario Draghi’s bazooka and unleashed an extension of quantitative easing on 4 August 2016 which could pump an extra £170bn of newly-printed cash into the economy. The BOE also cut the base interest rate for the first time in seven years, reducing it by 25bps to a new record low of 0.25%.

In addition to growth worries, the UK’s large current account deficit which amounts to over 5.5% of GDP, is an additional vulnerability for the GBP. Over the past few years, strong inflows of portfolio and foreign direct investment have helped to finance the external deficit. A deterioration in investor appetite for UK assets would complicate this financing.

On the bright side, UK exporters and the current account deficit could benefit from the weaker pound as exports become relatively more attractive than imports. However, with a negative trade balance of -£5.1 billion in June 2016, the weaker pound could result in higher inflation and further restrict the Bank of England’s options in the future. In general, a 10% devaluation in the GBP increase prices by 2-3%, all things remaining equal.

‘Leave’ voters who thought that things would be business as usual post-Brexit are sorely mistaken. The UK is at a critical juncture just like it was in the mid-80s and it will need strong Thatcher-esque leadership from Theresa May to negotiate a favourable trade deal with the EU and stabilise the economy. Failure to do so may cause the former world reserve currency to freefall into the unknown darkness below.

 

Picture courtesy of William Warby via flickr

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Reuters: Business News

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