Insight
Long day’s journey into economic night by Christian Odendahl and John Springford 11 July 2016
Economic developments in Britain since the referendum suggest that a recession is coming. And the politics of the negotiation with the EU suggest the country will suffer a prolonged period of weak economic growth. There are currently more questions than answers in post-Brexit Britain. The short-term economic consequences of the vote are no exception. We have attempted to clarify our thinking about what we believe will happen, through a series of questions and (sometimes tentative) answers. The pound has dropped to its lowest level in decades. Should I care? Yes. Sterling fell on a trade-weighted basis (that is, against a basket of currencies of Britain’s trade partners) by almost 11 per cent, while the euro and the US dollar are up slightly against other currencies. Such a fall in the pound shows that investors are concerned about the UK economy. But a weaker pound is not necessarily bad, is it? The UK’s current account deficit has been growing over the last two years, and now stands at 7 per cent of GDP. That is unsustainable over the long term, so Britain needs a weaker currency to rebalance. An economic argument should never start from a price change – such as a fall in the currency – but from the reasons for the change. The pound is falling for many reasons but two stand out. First, sterling assets will be less attractive to investors if they expect the economy to weaken and hence the Bank of England to cut interest rates (since rate cuts weaken the currency). Second, if investors increasingly fear that the UK will drop out of the EU’s single market, Britain will be a less attractive place to invest in new production facilities, and demand for housing and business property will be lower. As a result, sterling will weaken further. Regardless of the reasons for the weaker pound, exporters will surely benefit, will they not? That depends. First, a currency depreciation does not always do much to boost exports, with sterling’s fall after the 2008 financial crisis being a case in point. A falling pound does not automatically lead to a one-for-one boost to UK exports. Recent estimates have shown that a 10 per cent reduction in UK export prices leads to a 4 per cent rise in exports, which is not much. Second, Britain’s export markets need to be CER INSIGHT: Long day’s journey into economic night 11 July 2016
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