Attempting to second guess the foreign exchange markets can be a dangerous game. We have seen them go down, as they did the day after the referendum vote when the value of sterling fell by nearly 20 per cent. That happened however, in the eye of a political, not an economic, storm. And this week we saw the pound rise against both the Euro and the Dollar – seen as a response to two economic indicators, a further fall in jobless figures and October’s retail growth.
While many Remainers interpret any falls as bearing out the apocalyptic warnings issued before and since the vote, some Brexiteers appear to accept the pound’s collapse and turn their attention instead to tackling the consequences for inflation and Britain’s competitiveness.
Both reactions ignore the underlying economic question: was the re-pricing of the currency rationally justified-or was it an overreaction, driven by twenty something currency traders’ febrile reaction to political developments?
Currency values, like human skin, ultimately reflect the health or otherwise of its underlying economy. Whilst political events, like the exit from the ERM in 1992, the collapse of Northern Rock in 2008 and, (more beneficially for the pound), the return of New Labour in 1997, can cause short term shocks, generally these have been followed by a gradual realignment.
Research by Capital Economics and Deloitte, using data from Thomson Datastream, confirms such a readjustment was already happening pre-Brexit. The Effective Sterling Exchange rate had reflected a gradual recovery in the economy from the 2008 banking crisis- which was then interrupted by the hasty reaction to the Brexit result.
This conclusion is consistent with the view that in the longer term, sterling’s value depends upon economic fundamentals such as the economy’s growth rate, capacity to finance its trade flows, legal stability, human and capital infrastructure and the labour market. In the short term, however, market perceptions, even if irrational and at variance with these fundamentals, may predominate.
Thus, post Brexit market perceptions have been coloured by the uncertainty perceived to be an inevitable feature of the anticipated negotiations. It has been predicted to lead to lower investment, growth and confidence, followed by relative economic decline. The case that such perceptions might be destructively circular and self reinforcing, that they are not justified by the evidence, tends to have been allowed to go by the board. Instead and even despite the economy’s stoutly resisting the predictions, the ground has been ceded to the doomsayers.
For instance, in July EDX Capital predicted the UK was heading for a post-Brexit vote recession. In fact, OECD has just adjusted its growth forecasts for the current year from 1.7 per cent to 1.8 per cent – and last quarter growth was .5 per cent against estimates of just .3 per cent. Other commentators suggested that the economy could actually contract by .4 per cent in the third quarter, comparing the UK’s prospects to the 2008 financial crisis, the bursting of the dot com bubble and the 1997 Asian financial crisis.
The former Chancellor, George Osborne, even predicted an emergency budget, though in the event that did not happen. Mark Carney, the Governor of the Bank of England, who supported the Remainers, then insisted on a quarter point base rate reduction- which was ineffective and unnecessary, and possibly counterproductive. Mr Carney also persists in a Quantitative Easing programme which, according to Capital Economics, has left central bank assets in the UK at a higher proportion of GNP than either the US or the Eurozone. It also risks future inflation and hence further pressure on the pound.
Meanwhile the economy remains remarkably robust. Unemployment is low and job creation strong. Consumer confidence in September showed the biggest rise since June 2014 and retail sales have been up 6 per cent on a year ago. And as noted already, the good news goes for October’s retail figures: Glaxo Smith Kline continues to invest in Britain, and most telling of all, Nissan have confirmed their Qashqai and X Trend vehicles for Sunderland.
So perhaps after all, ‘all we have to fear is fear itself’. Instead of focusing on a potential disruption arising from Brexit, Britain’s politicians should recognise the supply side opportunities it prompts. It can lead to a more flexible economy, less unnecessary regulation and greater dynamism.
The Chancellor could make a start at the Autumn Statement by following his instinct for deregulation and by beefing up the Office for Tax Simplification in order to unravel a Gordian Knot and simplify an enterprise-stifling tax code.
Meanwhile the currency markets may be waking up to the opportunities Brexit offers to transform positively the British economy. The pound’s recovery seems already to have begun, so don’t cancel that foreign holiday just yet!