Sometimes events overtake us to some extent and the recent move has been a further fall in the value of the UK Pound £. Whenever this happens then old fears come to the surface and in many ways they are right to because such events have a mostly bad track record for the UK economy. However some things have changed as in the past we either had a fixed exchange rate or elements of one which meant that a problem, usually with the balance of payments could very quickly become a crisis as it did in 1967. Ironically later statistical revisions told us that it was in fact not necessary. Oh well!
This morning has seen the media out in full force on the subject of a lower UK Pound. From the BBC.
The pound dipped to $1.2766 in early trading on Tuesday – its lowest level against the US dollar since 1985.
Sterling has fallen sharply for the past two days as traders look to the Conservative Party conference for Brexit details.
Also the Financial Times.
The pound has skidded to a new three-decade low against the dollar as fears grow of a “hard” Brexit and its potential impact on the UK economy…..The pound has dropped 0.5 per cent against the greenback so far this morning to $1.2776, its lowest level since 1985.
The FT even gives us two reasons why.
a decline that has reflected the sharp deterioration in the outlook for the UK economy as well as expectations of further easing from the Bank of England.
I will come to the Bank of England in a moment but “sharp deterioration” is an interesting phrase from an organisation which you think might have been taught some humility by economic events so far after the vote to leave the European Union in the UK.
What about the Bank of England?
It should in my view be having a serious rethink this morning about its actions as its proclaimed “sledgehammer” for its monetary policy has no doubt contributed to pushing the UK Pound lower. I pointed out on BBC Radio 4’s Money Box program just over a fortnight ago that the lower UK Pound’s effect on the UK economy would be a “bazooka” compared to their “pea shooter” but even so some of the dimmer members at the Bank of England have been unable to restrain themselves. It was only on Thursday that I quoted these words from Dame Nemat Shafik and the emphasis is mine.
the process of adjustment can sometimes be painful. That’s where monetary policy can help, and it seems likely to me that further monetary stimulus will be required at some point in order to help ensure that a slowdown in economic activity doesn’t turn into something more pernicious.
Such pronouncements could be from the film “Dumb and Dumber” when you have already eased policy and have seen a substantial fall in your currency. Especially when you admit that things so far have turned out better than you had expected.
Bank staff have revised up their forecast for the mature estimate of GDP growth in Q3 to 0.3% from 0.1% at the time of the August Inflation Report.
Should tomorrow’s services PMI (Purchasing Mangers Index) turn out to be as strong as the manufacturing one (55+) and the construction one this morning which saw a return to growth another Forward Guidance embarrassment will likely be in play.
How much has the UK Pound fallen?
If we look to the effective or trade-weighted exchange-rate we see that as of last night’s close it had fallen to 76.7 which compares to 87.7 on the day before the EU leave vote and 90.4 on the last day of 2015. As ever we have fallen by more against some of which one must be the Japanese Yen and maybe even gained against one or two such as the Nigerian Naira but not many.
What is the economic impact of this?
Applying the old Bank of England rule of thumb gives us a monetary policy stimulus equivalent to a 3% Bank Rate cut since the vote and one of around 3.4% since 2016 began. However this is a boost to both inflation and economic growth or if you like nominal output. To get the real gain we need to know how much of it will be inflation. Back on the 19th of July I did some calculations.
If we look at the way that the UK economy is relatively more open than the Euro area and the fact that our fall was more against the US Dollar in which many commodities are priced I expect a larger impact on the annual rate of inflation than the Draghi Rule implies and estimate one of say 1%.
As we have fallen since then my estimate may now go as high as 1.5% for the boost to annual inflation. Many factors are of course in play here and as we look at the numbers now a price for Brent Crude Oil of over US $50 per barrel does not help when you are buying with depreciated UK Pounds!
By contrast the output boost is much harder to get a handle on. We do get some evidence as this from the Markit Manufacturing PMI shows.
The weak sterling exchange rate remained the prime growth engine, driving higher new orders from Asia, Europe, the USA and a number of emerging markets…..the weaker pound also bolstered export orders which increased at the steepest rate for 32 months.
There was also some evidence of this in last month’s services PMI release.
Companies linked greater demand to new clients, higher export business linked to the weak pound, higher domestic tourism and returning confidence following initial disruption related to the Brexit vote.
We of course await tomorrow’s update on what happened in September.
Let me return to my title and look at the issue of a sterling crisis. A real old-fashioned one in the style of 1967 cannot happen now as we do not have any element of a fixed exchange-rate. Whilst we can still have a balance of payments crisis the thresholds are much much higher now. Technically we have had a depreciation rather than a devaluation. If we compare to the depreciation which followed the collapse of the Northern Rock Building Society then not that either as the UK Pound fell from an effective exchange-rate of 105 in July 2007 to 77 in March 2010. Oddly a rather similar number to now. If we go back to 1992 the fall then was larger as well as we fell from 98 in July of that year to 81 in February 1993 as we first fell within our ERM ( Exchange Rate Mechanism ) band and then fell out of it completely.
Thus in terms of past sterling crises this is relatively small so far and of course events may change course or get worse. One factor that is at play here is the world economy which is showing some good signs as for example China rumbles on and we see in response changes in the commodity price pattern. But on the other hand there is the issue of why the Reserve Bank of India has today cut interest-rates from 6.25% to 6% meaning that @ReutersJamie can tell us this.
It’s only Oct 4, but India’s rate cut today means central banks have already eased policy more times this year (102) than last year (101).
According we wait to see if the next pattern will be more like 1992 (good) or 2007/09 (not so good). Here is some perspective from Macro Trends