Will this be seen as the sterling crisis of 2016?

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







21 thoughts on “Will this be seen as the sterling crisis of 2016?

  1. Hi Shaun

    I find the quote from Shafik interesting. She says that monetary policy is there to “help ensure that a slowdown in economic activity doesn’t turn into something more pernicious”. I interpret this to mean a slowdown in growth rather than an outright recession but, if this is the case, we seem to be back to a Gordon Brown future of”no more boom or bust”, a not merely absurd assumption that the economic cycle can be eliminated but that we have the possibility (probability) of ever lower rates to keep the (pernicious)recessionary wolf at bay. It would appear there is no end to stupidity as there is no end as to how low rates can go.

    I think that either inflation or a sterling crisis will force that hand of the BOE at some time and I do wonder what their reaction will be. I can’t see the insouciance or “look through” options working this time as everyone will then see the BOE for what it is: an organisation whose only purpose is to support a “bubble” economy and prevent necessary adjustments back to some semblance of reality.

    • Hi Bob J

      You make a good point about the combination of central planning and fantasy going on here. Do they really think that they can keep recessions at bay forever?

      I agree that any change of course for the Bank of England will be forced on them which will then prove that those Forward Guidance efforts were false.

  2. Hi Shaun

    Great article as alway.

    So we’re now entering fantasyland for the boe. A collapsing pound causing a rise in imported inflation which can be blamed on brexit. I can’t see them raising rates anytime soon, or else the uk’s no 1 asset (housing) will be toast.

  3. Shaun, this is a hot topic on the FT today. All the fault of Brexiters it seems. Our economy and vitality has been wrecked by the vote. So I agree that the sentiment against Sterling is a market reaction to the Govts position, seemingly choosing hard Brexit and worse planning to spend money we havent got on white elephants like HS2 or Hinkley.

    As I suggestd yesterday, this fake financial wonderland that the BoE has created may well discover that the rates suddenly are not as low as they thought…. and just because we made a plan to build some infrastructure.

    What a state we are in. Paul C.

  4. I can’t help thinking that Brexit is a “get out of jail” card for the Government/politicians and BoE…..if things go wrong it’s due to Brexit. If the economy does well (big if), then the Government has done a fine job.

    P.S. Read this blog every day, don’t understand all of it but I’ve learned a lot. Thanks.

    • Hi Mark and welcome to my corner of the world wide web.

      A pleasure. As to Brexit and its role as a scapegoat well it gets around. From the Bank of Mexico when it raised interest-rates last week.

      “. In the euro area, confidence indicators and credit conditions have not been
      deteriorated significantly, despite the departure of the United Kingdom of the European Union.”

      And today as the Reserve Bank of India raised interest-rates.

      “kept the rupee under downward pressure,
      which intensifi ed with the Brexit vote; however,
      the rupee recovered ground swiftly, as sentiment
      improved and FPI fl ows returned vigorously. Viewed
      in relation to EME peers, rupee moved in a narrow
      band, even as several other currencies appreciated
      in nominal terms, some of them going through
      corrections of sizable past depreciation.
      The bounce back from Brexit sustained an appreciating
      bias in the rupee’s movements into Q2, “

  5. The low pound could help reduce the UK deficit in trade in good and services and remove its negation to gdp. It doesn’t take much to achieve it and with all these export reports coming in there is at least a reduction in the negation coming along if not a positive contribution, yet.

    • Hi am

      It would be a really good result if the lower UK Pound £ kicked the UK economy forwards and helped with GDP via net exports. That was pretty much the 1992 story but sadly not the 2007/09 one. So we need a good world economic outlook to help….

    • Hi Forbin

      I am not sure that imputed crack would give the hit required! So I guess they will need the real deal.

      The price of corn futures has been rising a bit ( especially in UK Pound £) so even your popcorn may not help them.

    • plus growing inflationary pressures, plus increasing uncertainty around Brexit combined with the one certainty about Brexit which is that it will happen next year.

      Those gilt yields might not be so low for much longer the Debt Management Office had better get a move on and issue a few hundred billion worth this week for the future intended infrastructure expenditure.

  6. Shaun,
    The Euro must be a political rather than economic entity as Italy now joins the 50 year bond issue club despite its zombie banks!
    UK growth now upgraded by IMF despite or because of Brexit?
    It seems financial pundits now getting their Brexit retaliation in – better late than never?

    • Hi Chrislongs

      Sooner or later we will have bad economic numbers and the Twittersphere is particular seems to be ganging up. That of course is there choice except some have been rewriting their views.

      The IMF has embarrassed itself again with Christine Lagarde as ever to the fore. From the Guardian on the 13th of May.

      “A vote to leave the EU next month could precipitate a stock market crash and steep fall in house prices, the International Monetary Fund has warned.

      Christine Lagarde, the IMF managing director, also backed warnings from the Bank of England governor Mark Carney that Britain could fall into recession following a Brexit vote.

      Lagarde, who was in London on Friday to present the fund’s annual health check on the UK economy, said it was possible the economy would shrink in two consecutive quarters, which is the definition of a recession.

      “We have looked at all the scenarios. We have done our homework and we haven’t found anything positive to say about a Brexit vote,” she said.”

      The IMF said a panic among investors would trigger shockwaves throughout the economy following a vote to leave, sending shares and property prices into downward spiral.”

      Did we miss them? The FTSE 100 closed well above 7000 tonight.

      • Yes you did in terms of shares. The ftse 100 closed at 5740 on 24 June the day after the Brexit vote. I would call that a panic, albeit the ftse 100 recovered to it’s 23 June close a week later investors realised that the UK would be fine for the rest of 2016..

  7. How much of the movement in the pound or any other currency for that matter, due to just speculation and short selling? In all markets we see “sentiment” being the reason for rises and falls, I see it as a euphemism for making a quick buck. We all know there is an oil glut and in this post OPEC world production is not going to be cut back, so why is the price rising? Can only be “sentiment”.
    Th e U.K. has down much better than expectedi,post Vote, so why is the pound down?
    l would be more worried about the Euro, with Italian iand German banks on the brink.

  8. To my untrained eye,one of the main reasons for QE and ZIRP was to drive Sterling lower so that we could have export led growth.

    Now we’ve got growing order books thanks to weaker sterling,they want more QE because,well because……..

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