As traders caught their breath on Friday morning, following the pound’s dramatic overnight plunge, one strategist came up with a neat way of explaining the market forces at play. HSBC strategist David Bloom said: “The currency is now the de facto official opposition to the government’s policies.”
In other words, ministers at the Conservative party conference hint at a hard Brexit and the pound weakens, reflecting widespread fears the UK economy will suffer long-term losses and slip down the global rankings.
It is a new world for a currency once happy to bend itself to simple rules: generally, strong economic data boosted the pound, weaker indicators hurt it. Now, as Bloom points out, the pound has become a political and structural currency. As the Brexit drama plays out, sterling is subject to the utterances of divided UK ministers and EU officials, and to worries about Britain’s global standing.
Bloom also has an explanation for the pound’s path since the vote, which saw it take a dive, stabilise and then, in the last week, another lurch lower. “To us, the foreign exchange market is exhibiting an uncanny resemblance to the five stages of grief,” he wrote in a research note.
“First, following the Brexit vote came the denial – theories circulated whether a second referendum would have to take place. Second was anger – claims the vote was unfair. Third was the bargaining – arguments maybe it wouldn’t be that bad, what if the UK followed the Norwegian or Switzerland model. Now, the fourth – a gloom is prevailing over the pound.”
That gloom stems from worries that the government will put a crackdown on immigration above all else in Brexit negotiations. The price it will pay will be to end up shut out of the single market. The upshot is foreign investors find the UK less attractive, home-grown businesses face costly trade barriers, and the lack of access to skilled workers from overseas compounds their problems.
Economists see this as a frightening prospect for an island economy reliant on inward investment. Bank of England governor Mark Carney summed up the risks when he warned in January that Brexit could test “the kindness of strangers” that the UK relies on to fund its hefty current-account deficit.
These worries are best expressed in the pound, which hit fresh 31-year lows against the dollar on Friday. Even after recovering from a short-lived “flash crash” to $1.1841 in Asian markets, it was still down more than 1% at $1.2450 as a torrid week came to a close. On the day of the Brexit vote, 23 June, it was just below $1.50.
Grant Lewis, head of research at Daiwa Capital Markets Europe, noted sterling was the world’s worst performing currency over the last week. “Even over a longer time period, sterling now sits among a sorry band of currencies in terms of performance – since the start of the year only the currencies of Angola, Sierra Leone, Nigeria, Venezuela, Mozambique and Suriname have fallen by more.”
And there is worse to come, he warns. “Sterling’s all-time low against the dollar was $1.05 – if the government keeps careering headlong into a hard Brexit, a return to those lows is not unimaginable.” Bloom sees the pound at $1.10 by the end of 2017.
There are silver linings of course. Tourists have flocked to Britain’s luxury boutiques to buy cheaper watches. For exporters, the weak pound makes their goods more competitive.
But to focus on the boon to overseas sales is to forget that the UK imports more than it exports. And those imports, from foods to metals, have become pricier on the pound’s fall. British factories will pass those higher costs on to consumers, and sterling’s weakness will be felt at the tills.
And so to the fifth phase of grief: acceptance. Currency traders have already reset their expectations for the UK outside the EU. It’s time the public joined them in accepting a vote for Brexit was a vote for a weaker pound – and all that comes with it.
To QE, or not to QE
So, farewell then quantitative easing, aged seven-and-a-half. It was seen as the solution to the economy’s problems during the dark days of early 2009, but Theresa May thinks QE is doing more harm than good and has killed it off.
Or perhaps not. There are certainly side-effects associated with the Bank of England’s asset-purchase programme, which will be expanded to almost £450bn as a result of the new round of stimulus announced by Threadneedle Street in August. The object of QE is to drive down interest rates on safe government bonds and encourage investors to move into riskier assets such as shares and property. Not surprisingly, prices of these assets have gone up, enriching those who hold them. But those with assets in a bank or building society savings account have long been getting rotten returns thanks to rock-bottom interest rates.
May’s point is that the better-off have milked the benefits of QE while small savers have been hurt by the policy. The message from her speech to the Conservative party conference could not have clearer: this is not good enough and will have to change.
Yet when pressed in Washington about whether this meant the government was contemplating changing the Bank’s remit, Philip Hammond was unambiguous: it had no such plans.
Nor does the Bank share May’s view about QE. It accepts that there are distributional effects from asset purchases, but says that without QE, the economy would have grown more slowly and unemployment would be higher. It doesn’t accept that there are winners and losers from QE, rather that some gain more than others.
Given that this is the Bank’s strongly held view, it is not hard to envisage circumstances during Brexit negotiations in which Mark Carney tells Hammond that he wants more QE and needs the Treasury to indemnify the Bank against possible losses from the trades. In theory, Hammond could say no. But the smart money would be on him saying yes.
Tesco must tread carefully
Tesco’s latest offer for investors is a perplexing one – enjoy an increase in your share price, but then see your credit rating fall. The supermarket group’s share price surged last week after it reported a 1% increase in like-for-like sales in its half-year results, and chief executive Dave Lewis targeted a 3.5% to 4% operating margin by 2019/2020, well ahead of the present 2.2%.
However, ratings agency Moody’s swiftly warned that Tesco could face another downgrade to its credit rating – which is already at junk level – because of its £5.9bn pension deficit.
Despite Tesco’s recovery under Lewis, the deficit looms over the company. Given the repercussions from the BHS scandal – which saw the failed company left with a £571m deficit – and Theresa May’s tough talk on corporate governance, Tesco faces a delicate balancing act if it is to invest in its shops, make payments to directors and shareholders, and repair its pension scheme.
