One of the Brexit benefits is a weaker Sterling. In the post-GFC world, major economies have been taking turn to depreciate their currencies in order to boost their exports. Whether this is by design or just random policy events, I do not know.
Central bankers are basically following Economics 101: A country with a cheaper currency is more competitive internationally. Higher export earnings boost domestic economy to recover from a recession faster.
Of course, this assumes all other economic conditions remain constant.
For the UK, this assumption is becoming untenable. And because of this, the UK economy is potentially sailing into an economic trap.
Why UK Brexit Is Different?
Since 2009, there were varying degrees of manipulation on the FX markets to gain competitiveness for domestic exporters. Some were direct; some weren’t. Below I list some of these monetary policies used to influence FX rates.
FX Targeting Since 2008
| Country | Policy Used To Drive FX | Influence | Years Active |
|---|---|---|---|
| US | QE1, QE2, QE3 | Indirect | 2008-2014 |
| Switzerland | Peg to Euro | Direct | 2011-2015 |
| Japan | QQE | Indirect | 2013-Now |
| EU | QE | Indirect | 2015-Now |
| China | Managed Float | Direct | 2015 |
| UK | QE | Indirect | 2008-2012; 2016 |
Some of these monetary policies were prolonged. The Federal Reserve’s QE program, for example, lasted six years! (Oct-2008 to Oct-2014). Clearly, no country wants a persistently high currency.
Once monetary measures rolled out, the real economy generally benefitted – albeit with a lag. For example, Japan’s QQE only started to boost its economy in 2016/7; while ECB’s QE took 1-2 years to drive a sustained recovery across the EU.
The UK economy, unfortunately, will received no such sustained economic boost despite the fall in Pound Sterling. Why?
Trap 1 – Sterling is recovering
Sterling did not depreciate long enough for exporters to sustain its advantages. As I write, GBPUSD is trading around 1.40 – and occasionally trades just a few hundred basis points below its pre-Brexit highs of 1.50. Chart 1 shows GBP’s average value across 7 GBP pairs since June 2016. As of Feb-2018, GBP is down less than 7% – certainly not far enough to drive a renaissance in UK manufacturing.
Trap 2 – Narrowing export markets
UK’s main export market – EU – is being hampered by Brexit negotiations. Political posturing heightened uncertainties about impending tariffs. The loss of custom union will be devastating. More worryingly, there is this lack of transparency (and urgency) in concluding a deal with EU on services, the bulk of UK’s exports.
Right now, UK’s supply chain industry is being pulled apart because of Brexit. EMA/EBA have already found their new homes; there will certainly be more corporate relocations in the coming months. Workers will be displaced.
Common sense tells us that a weak currency will not benefit domestic exporters if their export markets are shut. UK is heading precisely into this trap.
Trap 3 – Tighter monetary conditions
UK pulled the QE policy too fast. The rate rise in Nov-2017, in my opinion, came in too early because it did not factor in the sharp rebound in Sterling in late 2017. A higher Sterling will drive domestic inflation lower in the coming months, reducing the need to raise rates.
Higher rates will damage the UK construction and property sectors – the engines of growth in the UK for much of the past six years. In 2018, house prices will probably soften further, construction sector wobble (due to Carillion), and foreign speculators hesitant to pile in (due to a rebound in Sterling and sharp rise in Stamp Duty).
With corporate and manufacturing investments falling due to Brexit, BoE probably needs another QE to maintain liquidity in the economy.
Trap 4 – Austerity
Austerity – a social program instituted during Cameron-Osborne era – remains in place. Note that austerity is liquidity draining. There will be less consumption.
Conclusion
The economic boost that followed from the Brexit Referendum is fading. More worryingly, the UK economy is sailing directly into the four economic traps listed above. Sterling is not weak enough to boost exports massively; whilst UK’s export markets are narrowing due to UK leaving the single market and custom union – the largest destination of UK exports. With the Bank of England now focussing on raising rates, monetary conditions will create headwinds for the UK property market. Taken together, the downside risk for the UK economy has just grown immeasurably larger.