We’re not complacent about the pound’s plunge, uncertainty is not helpful in financial matters. Brexit has added uncertainty but is far from the only factor causing this. Since the global crisis, almost a decade ago, central banks have been competing to devalue their currencies to support growth (or prevent deflation). The Chinese have always done it, to drive their phenomenal export growth; the Japanese have led the way since the crisis, having been stuck in an economic rut for more than a decade before the crash; the UK and USA responded immediately with QE and base rate drops; and the ECB followed, after initial resistance by the Bundesbank. America’s Federal Bank would love to raise its base rate and halt QE but is fearful of a rise in the dollar if they do. Following the Referendum result the BoE dropped rates to 0.25%, halving the already-meagre returns to foreigners. On top of everything the UK still has the highest deficit in the G7 group of major economies, and there is talk of big infrastructure spending to add to it.
It is no wonder sterling has fallen but what is the appropriate exchange rate? The IMF is not our favourite economic forecaster but its calculation of the appropriate value is based on current factors so is less prone to political bias than its notorious interference in the Referendum debate (and other EU-related mistakes, such as the Greek fiasco). Based on its trade-weighted value the IMF stated in 2015 that sterling was the world’s most overvalued currency and should be priced at around US$1.15. If this is correct then it seems Brexit was merely a trigger for a fall that was bound to happen.
The drop is very similar to that following our forced exit from the ERM in 1992, widely regarded as key to our subsequent economic recovery. But it is quite possible to waste the advantages of a devaluation, as Wilson’s government did in the 1970s. Evidence shows that exports are benefitting but the effect on consumer prices will show up soon. We hope the Government will hold its course on Brexit, despite its probable loss of popularity when inflation hits, and will wisely handle the opportunities presented by a better-valued pound.