The falling currency: A welcome adjustment?

Pounds

It turns out we were in a false reality. No-one believed that Brexit was really going to happen. The response to comments by Theresa May at the Conservative Party conference – and the realisation that Brexit is not only going to happen, but likely to be ‘harder’ than expectation – has been a plunge in the pound?  Time to panic?

In many ways, a falling pound has much to recommend it. It has already prompted a rise in the FTSE 100, as it raises earnings expectations for companies generating earnings in Dollars or Euros. It has also been great for those investors with chunky holdings outside the UK, who have seen the value of their global investments rise significantly. It is also great for our exporters, who now look more competitive on the global stage.

But this strength is not permanent. The link between a falling pound and a rising FTSE has already started to break down as investors have started to focus on other problems, such as weakening China growth. The trouble is, the drop in sterling is a one-off hit, and once earnings have been revised, it has to fall again to make any difference.

Then there is the inflation problem. Bank of England Governor Mark Carney has suggested that he is willing to ‘look through’ a spike in inflation as a result of currency weakness, but even if it doesn’t prompt a rise in interest rates as might be expected in normal circumstances, it leaves people paying more for goods on the high street and foreign holidays. That leaves less in their pockets for discretionary spending.

This is likely to exert a longer-term drag on economic growth. There is always the possibility that the fall in the pound becomes more disorderly. At the moment, policymakers seem to be willing to let it slide, but there will come a point when the negative impact will become more pressing and they will be forced to take action. That could precipitate a very uncomfortable moment for the UK economy.

So while it is tempting to be seduced by the immediate charms of a lower pound, it is worth remembering that it presents real risks for the UK economy in the longer-term.