Sterling’s unsung success story should be a confidence boost

Currencies are like referees. When you don’t notice them, they are doing a good job. So it is with encouraging economic portents that the British Pound has been gradually strengthening in recent times. Last week saw Sterling hit its highest trade-weighted level since the Brexit referendum almost eight years ago. This is not just a story of happier holidaymakers as they turn their minds towards the cost of a foreign holiday. It is also a sign that the UK economy is adjusting to the shock of Brexit trade frictions, imported energy price shocks, and the disruption from a global pandemic.

The impact of a stronger Pound – at least at the margin – is to dampen imported cost inflation in consumer staples such as oil, gas, and food. Moderation in these prices has contributed to indicators of sentiment turning more upbeat. UK consumer confidence has just hit a three-year high according to GfK. The Lloyds Bank Business Barometer is now at an eight-year high. These are important metrics on the economic outlook for the second half of the year.

I was struck in the immediate aftermath of the 2022 Mini Budget how – as the value of the Pound tested its post-Brexit vote lows – business activity stalled as UK supply chains, reliant on overseas components, struggled with unstable exchange rates and volatile pricing. Whilst UK government debt discounted the “moron premium” of bad governance rapidly after the change of Prime Minister in October 2022, the scarring of private sector activity persisted well into 2023. This culminated in a shallow recession at the end of last year. However, with a General Election just a month away – and a new UK government not exactly poised for a golden economic inheritance – at least the currency markets are one less thing to worry about.

The same upbeat message for the British Pound cant be repeated for several important economies and currencies around the world. Here the backdrop, particularly heading into a seismic US election season, is fraught. The strains of a strong US Dollar are manifesting themselves from Japan to Argentina, from South Africa to China. Just last week Japanese policymakers revealed they had spent sixty-two billion dollars over the course of the last month to protect the Japanese Yen. Even this huge intervention barely moved the Yen off its all-time low valuation. The new economic policies of President Milei in Argentina have led to the official value of the Argentinian Peso losing 60% of its value since November. Black market rates for the Peso are even less favourable. With inflation now touching 300% a year any attempt from Milei to remove capital controls – a stated aim of the administration – is fraught with danger. In South Africa the halving of the value of the Rand against the US Dollar over the last decade helped trigger the backlash seen in last week’s election that saw the African National Congress lose its majority for the first time since the end of Apartheid in the early 1990s. Meanwhile China remains a fascinating example of an economy tightly bound with the US and yet now experiencing sharply divergent economic conditions – low inflation, deflating asset bubbles, and low consumer spending. Key currency indicators suggest that the Chinese Yuan needs to weaken and yet Beijing policymakers – worried about capital flight amidst low domestic interest rates – are holding the line. This is an unstable equilibrium in China, both economically and politically. The Biden administration or President Trump, already anxious about dumping of green technology in international markets, will happily label the Chinese as currency manipulators on any sustained Yuan weakness. There are no easy steps from here.

Even in the Eurozone, which looks set to be the first major economic area to begin easing interest rate this week, there is concern over currency risk. Whilst Eurozone policymakers have been at pains to state they can move monetary policy separately to the US and the Federal Reserve – which is unimpeachable logic given the very different levels of demand between the US and Europe – any direct action may trigger a significant move lower in the value of the Euro. The second tier of European central banks in Switzerland and Sweden have already taken steps to ease borrowing rates and there has been a noticeable underperformance in recent months by both the Swiss Franc and the Swedish Krona. 

So what do these disparate stories from all around the world tell us about exchange rates? In short, their strains are symptoms of a global economy that retains deep imbalances. Some countries consuming beyond their means, funded by others consuming too little and saving too much. Another group of countries have sustained trade deficits, unable to adjust their terms of trade as surplus countries aggressively protect their own trade position. The result of these imbalances is that exchange rates – after arguably forty years where they have been a side issue in economic policymaking – are returning to the front pages across the world.

For the UK knowing the right path to take is not straightforward. On the one hand there is a respectable argument that for decades the British Pound has been too strong due to an outsized financial sector that has undermined the ability of more tradeable, industrial sectors to compete in global markets. But the alternative argument is that the two big Sterling devaluations of modern times – in 2008 and 2016 – triggered significant contractions in real household spending power as a Pound earnt bought rather less internationally traded goods and services. No government will seek a third such episode anytime soon.

And so this takes us full circle. A good aim for the next government is to keep the Pound out of the headlines and pursue a “good refereeing” policy. It may help explain why the Labour Party are so reluctant to announce anything in their economic agenda that could trigger economic uncertainty, or a deviation from the status quo. As Liz Truss found out, a country like the UK with large trade and fiscal deficits, can’t buck the market. Least of all currency markets.

Published on The Times: 03/06/2024