Insight
Sterling slump won’t rescue the British economy by John Springford and Simon Tilford 21 October 2016
Sterling has now fallen by around 15 per cent in trade-weighted terms since Britain voted to quit the EU. Opponents of Brexit have argued that the British are markedly poorer than they were, because the devaluation was in effect a write-down of the value of UK assets. They have also argued that the weakening of sterling will push up inflation, depressing real incomes. If the currency falls further, it could even force the Bank of England to raise interest rates in order to shore up investor confidence in the British economy and stabilise the currency. That would increase the cost of borrowing for firms and households and depress economic activity. For their part, Brexiters portray the fall in the value of sterling in a positive light. They claim that it will boost Britain’s exports and help neuter any negative impact from leaving the EU’s single market. Some commentators also claim the pound’s devaluation will shift economic activity away from the dominant services sector in London towards manufacturing in other parts of Britain, arguing that the strength of London’s internationally-traded services sector elevated the pound to a level that rendered these regions uncompetitive. To assess whether lower sterling will boost UK exports, we need to look at what impact previous depreciations had on foreign demand for British goods and services and also on the changing structure of British exports. The bad news for Brexiters (and Britain) is that the current weakness of the pound is unlikely to provide much impetus to exports. Following the steep fall in the pound after Britain left the Exchange Rate Mechanism (ERM) in September 1992, Britain’s trade balance did improve (see Chart 1). The country’s trade deficit halved between 1992 and 1993 and again between 1993 and 1994, as growth in goods exports outpaced imports by a significant margin. But even during this period – often cited in the UK as an example of currency depreciation leading to economic rebalancing – the overall adjustment was pretty small. Britain’s trade deficit was 0.7 per cent of GDP in 1992 and by 1994 this had closed. Net exports (that is exports minus imports) contributed just one tenth of the growth in British GDP between 1992 and 1994.
CER INSIGHT: Sterling slump won’t rescue the British economy 21 October 2016
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