How bad is BREXIT for the Pound?

RobAllen 141Even before the UK’s Brexit vote was official, the pound’s value plummeted. It has been much reported that sterling has hit record lows. That’s not to say Brexit has precipitated a full blown crisis, but a sterling recovery in the short term is not to be expected.

The pound fell to £1 to US$1.28 in the two weeks after the Brexit result.

According to Alain Naef, University of Cambridge, this has only been reached once in all the time these two currencies have existed – for a two-year period in the 1980s. And in the 1980s, the low rate was not due to a fundamentally weak pound, but to a strong dollar. All European currencies at the time fell against the dollar and were saved in 1985 by the Plaza Accord, a commitment by the US and Europe’s major economies to support their currencies through market intervention.

Harvard economists Carmen Reinhart and Ken Rogoff define currency crashes as any drop of 15% over a year. By these measures, the aftermath of Brexit can be seen as a currency crash. However, it is not yet a full-blown crisis, as the impact on the economy is not yet clear. A lower pound might be good for British exports, but not for housing or finance.

Latest foreign currency reserve figures published at the end of June showed that British reserves actually increased between May and June, in line with the trend of previous months. This would indicate that the Bank of England has not yet used its dollar reserves to support the pound. This has been the Bank’s policy since shortly after 1992, when it lost £3.3bn to speculators on Black Wednesday.

What would help sterling recover is positive news about the balance of payment (the current account deficit sat at £32.6 billion in March 2016), a rise in interest rates or overall economic growth. But due to all the economic and political unrest following Brexit, none of this is likely to happen in the near future so a further depreciation can be expected.

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by Rob Allen