The plunging pound: Britain’s shock absorber

The falling value of the pound will boost Britain's competitiveness, says Andrew Van Sickle. But don't expect a huge new upswing in the economy just yet.

"The history of the pound against the dollar over the last century is essentially a downward ladder with big permanent steps," Oxford University's Rui Pedro Esteves told Bloomberg.com. The world's oldest currency bought almost $5 during World War I. Now sterling buys around $1.30, down from $1.50 on the day of the referendum. Since then it has also fallen by around 10% against both the euro and a basket of leading trading partners' currencies. There could be further falls. The current-account deficit reached almost 7% last quarter, while the pound basket, or trade-weighted index, is only at a three-year low.

What does this mean for the economy? Many analysts have noted that falls in the pound have been associated with upswings in the past, notably when we left the gold standard in 1931, triggering a 30% drop in the pound. In 1992, leaving the European Exchange Rate Mechanism also fuelled growth. A lower currency should improve competitiveness by making exports and inward investment cheaper.

But don't count on a big boost this time. There will certainly come a point when foreign investors decide that our assets are a bargain. "As with everything in economics, things can get back into balance at the right price," says Buttonwood on Economist.com.

But investors' enthusiasm may be tempered by the uncertain outlook. Foreign and domestic confidence may be subdued until the contours of our deal with the European Union take shape.

As for the export boost, in the 1930s we exported large volumes of price-sensitive products, such as coal and steel, so having a cheaper currency was a boon. These days we export mostly high-quality manufactured goods and services, which are much less price-sensitive. Companies may also decide to book their higher foreign-currency receipts as extra profit instead of cutting prices. World trade is also lacklustre, in stark contrast to the 1990s and 2000s.

Back then, globalisation and an expanding European market powered growth once the fall in the pound had been reversed in 1996, says Andrew Sentance in The Daily Telegraph.

Another effect of the falling pound is a rise in inflation through higher import prices. As we saw after the 2009 recession, that erodes purchasing power and hampers consumption. Deutsche Bank is pencilling in inflation of more than 3% in three years. The upshot is that on this occasion the plunging pound should prove to be an economic shock absorber and give our competitiveness a modest fillip, rather than underpin a huge new upswing.

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