What a long-term weak pound means for the U.K. economy

LONDON – British Pound Exchange Rate to U.S. dollar have been on a roller coaster ride in recent months.

After a year of steady decline, it fell to an all-time low below $1.10 following the UK government’s infamous “small budget” in late September. It then recovered to 1.16. dollars after the country swapped finances and prime ministers in late October; and fell to $1.11 after the Bank of England lowered expectations for rate hikes and warned the UK had begun its longest recession ever on November 3.

The recent highs and lows have both taken place in a range where the pound hasn’t traded against the greenback since 1984. In mid-2007, before the height of the financial crisis, people were can get two dollars for a pound. As of April 2015, it was still worth $1.50; and at the beginning of 2022 it’s 1.3 dollars.

Almost all currencies fell against dollar This year, and the pound’s devaluation against the euro is not so severe given the European Union’s own challenges with the slowing economy and energy supply.

But the euro remained much stronger against the pound in the 1990s and for most of the 2000s; and the global importance of the pound has disappeared since its days as the world’s reserve currency in the early 20th century.

Economists told CNBC that historically weaker sterling in the medium to long term has more of an impact on the UK.

The most basic thing is that imports become more expensive, while exports theoretically become more competitive.

Mark Blyth, professor of economics and public affairs, said: “The problem is that the UK is heavily dependent on imports, almost two-thirds of food is imported, so the real exchange rate falls. 10% actually translates into higher food prices. at Brown University.

“The UK is a low-wage economy. That would hurt.”

Richard Portes, professor of economics at the London Business School, also notes the UK’s reliance on foreign trade, which means there is a “significant” price impact from a weaker currency, although he thinks There is still no evidence of a significant effect on UK demand. for foreign goods – but also not for exports, theoretically becoming more competitive.

He also noted that currency devaluation has a greater effect on prices than on inflation.

“It’s a one-time effect,” he said. “If it’s contributing to a wage price spiral then it’s inflation, and that’s what we’re all concerned about right now. We don’t see what to expect to see these price hikes happen in part because of that. Ukraine, etc., we don’t” I don’t want to see wage increases triggering price increases and spirals. “

“I think that’s going to continue to be a long-term trend since it was allowed to float in 1971,” he told CNBC. our trading partners. So that’s the long-term situation. “

The UK’s current account deficit (where a country imports more goods and services than it exports, and stands at £32.5 billion for the UK) is financed by capital inflows, he noted. Former Bank of England Governor Mark Carney has said the UK is dependent on the “kindness of strangers”. But Portes said “it’s not their kindness, it’s that they want to invest because they find the forecasts and yields viable, investors find UK assets attractive enough to bring capital back.”

“If they find it less attractive, UK assets will depreciate in value to get people to invest more, so the exchange rate will fall further. That depends on confidence in the economy. UK, fiscal policy and all that.”

However, Portes said, the weaker pound itself is not an issue for the fiscal plan the government is currently working on, with a much-anticipated budget due on November 17.

“If a lot of our debt were denominated in foreign currencies it would be, but it’s not. Our public debt is almost entirely in pounds. And so, unlike some countries, they are. I don’t see a problem. I don’t think the decline we’ve seen or are likely to over the next few years will make much of a difference to financial positions.”

According to Blyth, in addition to the pain suffered by households, higher prices caused by a weaker currency will have a deeper and more lasting impact.

“The UK is a heavily consumption-driven economy and such a change is tantamount to a consumption tax. That means the economic engine will be less fuel. The UK already has a level of consumption. low growth and even lower productivity growth.”

The potential for increased exports has been negated by Brexit, he said, pointing out that the UK economy has shrunk from 90% to 70% of the size of Germany since the 2016 vote.

“So what does this mean in the long run? It means the old UK growth model is dead,” Blyth continued.

“Financing your consumption from other people’s savings (imported capital) and swapping expensive homes has a shelf life. It’s over.

The appeal of low-priced British assets can only be sustained if they are revalued and “GBP is not USD,” he said.

Blyth believes that adapting to this new reality will be difficult but necessary in the long run.

“A larger London independent UK generating 34% of GDP, with the transfer of lives from the north and west, is a better UK. To get there will only take time. , imagination and investment.”