Readers question: How much will the Pound devalue?
Since the start of 2016, the Pound has been depreciating against other currencies – especially the US dollar. Since Brexit end of June, the Pound has fallen another 10% heading to a 30 year low against the US dollar.
Pound Sterling against the Dollar
This is daily spot rates, from the Bank of England. But is already out of date, with the Pound falling on 6 July to $1.28.
Why Pound may fall further
1. Current account deficit. The size of the UK current account deficit 6.9% of GDP in the last quarter – shows the UK has an imbalance between imports and exports. It is a near record size deficit since records began in 1955. (record was the 7.2% deficit in Q4 2015). This size of current account deficit will place strong downward pressure on the value of the Pound. The outflow of currency to buy imports is unsustainable without a corresponding inflow of capital and financial flows to finance it.
2. Overvalued. Back in 2014, the IMF reported it felt the Pound was overvalued by 5-15% because of “lack of competitiveness and limited export diversification”. This lack of competitiveness is reflected in the current account deficit. Limited export diversification may have been a factor in the limited improvement in the UK exports during the Sterling depreciation of 2011-13 (though Eurozone weakness was also a factor).
3. Capital flight from UK. Although there is a temptation to get carried away by bad news post Brexit, there does appear to be less willingness for foreign investors to keep money in the UK. Outside the EU, the uncertainty and loss of direct access to the Single Market, makes UK economic prospects weaker and due to this, some investors are moving money outside the UK, or at least not investing in the UK, with this decline in foreign portfolio flows, the previous factors keeping Pound strong have been removed.
4. Decline in capital investment (inward investment). The other aspect of the UK financial account on the balance of payments was the direct inward investment (foreign firms building factories in the UK, e.g. Chinese investment in power plants). Post Brexit, these plans have been put on hold, and outside the Single Market, there may be a long-term decline in desirability of investing in UK. Without these direct inward investment flows, there will be downward pressure on Sterling.
5. Previous falls
In 1992-1993, after leaving the ERM, the pound fell 29%. During the financial crisis, the Pound dropped 34%. It is possible we could see a similar major revaluation in the value of the Pound. This could see the Pound fall against the dollar towards $1.15.
6. Monetary easing. The Bank of England have indicated that they will cut interest rates to 0% to protect economy against decline in spending. It raises scope of potentially more quantitative easing. This monetary easing, will reduce value of Pound. Lower interest rates make it less attractive to save in the UK.
Any good news for the Pound?
In this current climate, it is hard to see any good news for the Pound. If the real exchange rate is overvalued by 10%, the shock and uncertainty of Brexit is likely to make this revaluation happen. However, sometimes markets over-react to perceived bad news, such as Brexit. It could also be other economies, such as US and Eurozone see a similar economic downturn to the UK, in which case the fall in the Pound may be halted.
One thing that may happen is that as the Pound falls, we see changes in consumer behaviour, e.g. UK citizens avoid more expensive foreign holidays, and exports rise. The fall in the Pound will be self-correcting.
- Who wins and loses from a falling Pound? – why a falling Pound can be beneficial for aspects of the economy