What is the economic impact of the post Brexit UK Pound fall?

Yesterday saw England rudderless and confused with a poor performance from Sterling. But enough about the football although let me congratulate Iceland and wish them good luck in the next round. As we have a spell of market calm this morning with the FTSE 100 up 2% at 6100 as I type this and even the poor battered UK Pound £ rising above US $1.33 there are opportunities to take stock. An early lesson is a type of shock effect both emotionally and in the way that financial markets can move far far faster than the economy can respond. Whilst it has many flaws in other areas rational expectations economics has some success here although of course the obvious rejoinder is what do we rationally expect now?

Ratings Agency Downgrades of the UK

Once upon a time these bodies bestrode the world and economic agents were afraid of them . If they sliced a notch off a credit rating then the “bond vigilantes” would ride into town driving sovereign bond yields higher and making it more expensive for that country to borrow. The credit crunch hurt them in two ways starting with the way that debt they rated as “AAA” turned out to be a lot further down the alphabet in reality. Also as events like the Euro crisis hit they ended up chasing events rather than leading. They have survived because the need for measurement and analysis has risen in the credit crunch era and that has offset to some extent the plummet in their credibility.

So let us get to what they told the UK yesterday. From Standard and Poors

Ratings On The United Kingdom Lowered To ‘AA’ On Brexit Vote; Outlook Remains Negative On Continued Uncertainty.

This had particular emphasis for headline writers as it was the last of the ratings agencies to have the UK as AAA. Around 5 years ago I pointed out that we did not really deserve such a rating as whilst we have our own currency and could always print as much as we wanted that would likely be accompanied by a lower value of the UK Pound £. Also Fitch wanted a slice of the action as Reuters reported.

Fitch Ratings cut Britain’s credit rating on Monday and warned more downgrades could follow, joining Standard & Poor’s in judging that last week’s vote to leave the European Union will hurt the economy.

Fitch downgraded the United Kingdom’s sovereign rating to “AA” from “AA+” and said the outlook was negative – meaning that it could further cut its judgment of the country’s creditworthiness.

Some kept a sense of humour about it all.

Fitch downgrades UK to AA/neg now (@NicTrades )

A Wider Perspective

These days the story does not end there as you see there are much wider trends and themes at play. Overnight we have seen yet another example of the move lower in sovereign bond yields.

| *JAPAN’S GOVERNMENT BONDS ALL YIELD LESS THAN 0.1% FOR 1ST TIME

Apologies for the capitals used. If we move beyond that there is plenty of scope for reflection that the highest sovereign yield in Japan is not even 0.1%! Each time we see such a move I point out that business models which depend on yield such as pensions and annuities cannot work anymore.  The ten-year yield is now -0.22% which fits poorly with all the proclamations of economic recovery. Overall we see this.

Japan’s long yields on the road to zero. 40-year falls to record 0.08%, some 80% of JGB market is now sub-zero ( @HaidiLun )

Back in the UK

The story of the bond vigilantes riding into town has quite a reverse here. It was only yesterday that I pointed out that our benchmark 10 year Gilt had seen its yield fall below 1%. So yields are surging today in response to the downgrade? Er well no, as it is at 0.97% as I type this so on the edge of all-time lows ( since 18th century according to Ed Conway of Sky). This is a little higher than the lowest of yesterday but not much and this of course is a response to the higher level of the stock market. The thirty year Gilt yield is at 1.83% which in terms of my time following it is simply incredible.

So those looking for a response to the ratings downgrade only have inverse responses with Gilt yields extraordinarily low and the stock market and UK Pound £ rallying.

The impact of the lower UK Pound £

There have been a lot of headlines about the UK Pound £ saying it is a 31 year low or was yesterday. Many have forgotten to point out this is against the US Dollar which of course has been in a strong phase and overall we have seen falls but mostly smaller ones elsewhere such as to 1.20 versus the Euro.

As we have reached a calmer phase I can complete some calculations as the Bank of England only compiles its trade weighted index daily and is based on yesterday’s close. Thus we came into 2016 at just over 90 and are now at approximately 80. So using the old Bank of England rule of thumb we have seen a move equivalent to a Bank Rate reduction of 2.5% so far in 2016. Compared to this time last year it is more like 3.25%.

We can expect an inflationary push as well especially as the fall has been loaded towards the US Dollar. Many basic commodities will be seeing a push higher from this as it added to a falling trend anyway although there will be some offsetting from the falls in the oil price over the past few days. Over the past year the oil price (Brent crude oil -24%) has fallen more than the UK Pound £ (-15%) but over the last week it has fallen by less. So upwards but not by as much as those who have missed the oil price fall have suggested.

Comment

There continues to be much to consider as a multitude of economic events occur together. What it shows us is how tightly the world financial and economic system is tied together. Some of this is good as in manufacturing efficiency but some of it is not so good as complacency and bluster about the banks turns to near panic in an instant. On that subject whilst he is not always right this poses a question. From De Welt.

George Soros is betting 100 million Euros against Deutsche Bank

Meanwhile we have received an increase in uncertainty followed by an inflationary economic boost provided by the fall in the UK Pound £. Just what some at the Bank of England have called for over the years so it is no surprise to see former Governor Baron King reappearing in the news. In fact quite a few economists have called for that although it is nice to see the Resolution Foundation backing up one of my themes.

Housing wiped out 2/3 of post-2002 income gain. RF report on underplayed role of housing in living standards squeeze.

Steve McClaren

If you need some light relief at a difficult time you should watch this rather spectacular effort.

 

 

 

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25 thoughts on “What is the economic impact of the post Brexit UK Pound fall?

    • Hi Martin and welcome to my corner of the blogosphere

      If you mean interest-rates and bond yields whilst we do not know where they would be if we have a more stable political scene probably not much if at all. Foreign exchange rates are quite different and yes I think that the UK Pound £ has fallen more than it otherwise would due to the political problems.

  1. I find it incredible that the EU is proposing to ‘act tough’ with the U.K. During negotiations to leave, as a deterrent to others who might have the same idea. Has no one learnt anything from the Soviet / eastern block era? If you have to frighten your citizens into staying with a political project then it contains the seeds of its own destruction. I would have thought at this stage they would be asking serious questions about the unpopularity of their own project and what needs to be done to get the people of Europe back on side.

    Following yesterday’s market fall there is going to be some serious money made on the way back up when markets realise that the UK will still trade with Europe and very little will ultimately change.

    • Hi Pavlaki

      I saw someone write a piece a while ago on the five stages of grief/loss and I think that anger was number 2. So we are in that phase for some both here and abroad and then I think most people will begin to adjust. Ah I have found it now.

      “denial, anger, bargaining, depression and acceptance.”

      I gather that it can come in different orders.

      As to what I have heard then it has gone both ways. We can expect a good deal and a bad one! I hope rationality prevails as we could pull each other done.

      • The fight will go on. Boris the clown will be PM, but has already indicated that he doesn’t want an early GE, which is probably a Brown error. So, when it comes to the deal in 2 years, he will be forced into a second referendum over Single Market plus free movement versus pulling up the drawbridge. However, two years of failed economics, no immigrants being deported and less cash for the NHS will also force a third option – return to the EU without Cameron’s hokey-cokey.

        “The point of political policy is not to be right, but to be right in the end”
        Konrad Adenauer

  2. McLaren sounds like Garage and Eddy Hitler announcing how the strength of the UK economy will mean we will get whatever we want from Europe.

    King is a fool – we have tried devaluation since 1967: What have we finished up with? Oh, some of the biggest trade deficits in history http://www.bbc.co.uk/news/business-36256358 and ironically, the biggest ever with the EU (some position of strength). The gap has to be made up with imported capital, which is fine if the currency is stable and asset prices are inflated,. but the foreigners in Central London have been checking out for some months already.

    Devaluation has been the crutch on which poor British commercial management has relied since the 60s. A currency constraint like the euro will be tough for the bone idle of the Mediterranean, but [pretending you can devalue your way out of any problem is just putting of the evil day.

    • Hi David

      Steve McClaren has form as those who have seen the interview when he tried to speak with a Dutch accent upon appointment as manager of a Netherlands club.

      I am no particular fan of currency devaluations either but with Mario Draghi warning against competitive devaluations tonight they seem to be on official minds. The same Mario Draghi who has pushed the Euro lower with his negative interest-rates and even expanding QE portfolio….

  3. Hi Shaun

    One question you don’t answer about UK bond yields is this: why do people buy them at these yields? It seems to me that you would be better off holding cash, particularly now and that the current yields in no way compensate for the potential risk involved. Do pension funds and insurance companies have to buy gilts?

    Also the fall in sterling presages another “look through” episode at the BOE as I think that last thing they will do under the current circumstances is to increase IRs. The irony is that Brexit has in fact provided Carney with just what he wants, despite him being for Remain; a fall in sterling to boost inflation and hopefully get rid of debts and the use of Brexit as an excuse not to raise IRs – despite the fall in sterling. Of course the increase in inflation is only really useful if there is an increase in earnings and that of course may be somewhat more problematical

    • traditional to buy them but there’s talk of them being not fit for purpose .

      in a crazy world still in majickal finance post 2008 , its not over yet , world , a safe but slowly deteriating gilt is safer than buying , say , Argentina’s bonds/gilts , or Greece’s

      Forbin

    • It is a case of where do you go when you seek safety for assets – cash is returning nothing or is rather inconvenient to store. Shares carry risk and derivatives even more; the property bubble is about to burst and is not a liquid market anyway.

      The demand causes the price to rise and thus the yield to fall, but at around 1%, that is still 10x better than say an average savings account, where many ordinary people have kept their cash.

    • A point I’ve made on here a couple of times, is that, to sell these bonds to people who don’t have to but them implies huge risk everywhere else.
      So what are they not telling us?

    • Hi Bob J

      I will add two more to the list in that it is a safe way of having a currency punt, excuse me considered investment. It is not always at the shorter -end although logically it should be. The other is a bubble type mentality where the only way is up.

  4. ” Supermarket prices could rise if the pound’s fall continues, retail analysts have said. ”

    along with petrol prices

    which in part is the inflation that the BoE has been wanting all along

    if it happens of course , also with falling house prices , which I predict will majickally find its way into CPI …….( at least in much stronger terms)

    So we will get inflation , lower bond/gilt yields , you would have thought someone would be happy

    Forbin

    • Hi Forbin

      Ha 🙂 You think I will get my way just before house prices fall! I have at times wondered that myself but mostly have concluded that they are not that good. But you never know there may come a time when it is obvious and will last.

      Some of this as you say is a Bank of England dream ticket as it gives them what they want and also a shock provided by Brexit where they can claim they have been forced to abandon Forward Guidance. Bit of a clash between the lower yields and higher inflation….

      • ” they can claim they have been forced to abandon Forward Guidance” – now there is something we haven’t heard for some time. I suppose some of the economic warnings could be construed as FG, but they seem to have lost that moniker.

  5. Hi Shaun I echo the views of Bob J why would any insititution buy Government Bonds yielding nothing or less than nothing.
    The Japanese 20 yr is yielding almost zero…unbelievable,the Yen is regarded as a safe haven?
    There is no plan the political parties are in disarray yet there is a currency and stock market rally,thought markets didn’t like uncertainty,…..this is greatest point of uncertainty in my lifetime.
    Deutsche Bank and several Italian Banks appear to be in severe trouble,yet bond yields continue to go lower I thought these were meant to reflect risk?
    When will markets yields and currency reflect reality .Frau Merkel has been clear if Britain wants access to the single market we must accept free movement of Labour there can be no cherry picking…The argument that German car makers would be hurt by this was refuted by the obvious point German car makers are not at the negotiating table.

    • Surely in Germany industry may not be at the table, but it is directing negotiations….
      To borrow a phrase from the CE of Sunshine Desserts(?), Germany “didn’t get where it is today without knowing…” how to help its own industry.
      The Euro was designed specifically to help Germany escape from a strong Deutschmark, something spotted by Nick Ridley many years ago.
      Was he the best Chancellor we never had…..?

      • Chancellor Kohl did not want the euro, but accepted it in a compromise deal with the French in return for their support of re-unification. Be careful what you wish for, because you might get it

        • Thanks. I had forgotten the precise background. Germany won twice, re- unification plus economic dominance!
          I seem to recall the prevailing wisdom was that absorbing and repairing East Germany was going to hold back Germany for a long time…. So much for “expert commentators”!

        • Economic dominance comes from setting up an environment where businesses can thrive. Near the French border, French firms struggle under a hefty tax regime whilst their German counterparts stride ahead with a lighter burden. German education system is adapted to produce usefully skilled workers.

          But in Eastern and Central Europe the German firms were keener to set up in the Visegrad countries, because East German workers struggled to deliver productivity at West German wages. The 2004 EU expansion was a slow burning, yet huge change. Average wages between old EU members and former Warsaw Pact countries are still far apart and have more adjustment to do.

  6. The big 3 ratings agencies discredited themselves over the mortgage derivatives that they rated AAA in a simple conflict of interest. No serious investor should use their data, but they are useful as a circus act in our central bankers show.

  7. Hi Shaun, I’m reading the Venezuala crisis is worsening. Hyperinflation, basic food deliveries failing and airlines like Lufthansa pulling out because currency restrictions prevent payment. The lesson I’d draw is on the importance of monetary stability and effective markets. Osborne, Draghi & Juncker should take notice.

    • Hi ExpatInBG

      You are right about the ratings agencies and I think many of the main investment funds do their own reports now for obvious reasons. Venezuela is a mess which was being lauded by some in the UK only about 2 years ago. They should be ashamed of themselves.

      As to monetary stability we seem to have abandoned all pretence as we get “more,more,more”

  8. Meh. This is 1929 all over again. The only lesson learned from 2008 is “build a bigger bubble.” All a low to even negative yield means is the market has a profound concern over a return of not on capital. “Yield hungry investors” have been warned by the Treasury yield curve that they have done exactly the wrong thing since Lehman and Madoff…namely think prices can only move in one direction (higher of course.)

    Those who have consistently bet long (selling call options for example) have done great without working very hard. Shortsellers on the other hand have been obliterated….paying massive dividends out to folks who just sit on their money anyways.

    At some point all of these speculators get annihilated…they always do.

    None of them have the staying power, the wherewithal or the “breathing space” to handle the fall. They’re all guided by pure emotion and “momentum” trading.

    Some big real estate projects heading south in New York…that won’t stop the spending of course…but one corruption scandal and folks will look at the 70 billion Puerto Rico defaulted on and thinks it’s a nothing.

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