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What is the effect of the falling pound on Brexit Britain?


“People who bet against Britain are going to lose their shirts,” Boris Johnson asserted in his first speech as prime minister last week. But his willingness to risk a no deal Brexit has spurred sterling’s depreciation: the currency has now lost 4 per cent against the dollar since the start of the month.

A weaker currency might please policymakers in the US or eurozone, where inflation has consistently undershot target, but in the UK’s case the depreciation brings no upside for the economy.

Nick MacPherson, former permanent secretary to the Treasury, warns that “benign neglect” of sterling instead “carries huge risks, the more so since recent devaluations have done little for exports, while unambiguously cutting living standards”.

Who loses from a weaker pound?

People might not feel too deeply for the middle class holidaymakers who found exchange desks at Heathrow quoting sterling at parity with the dollar and below a euro on Tuesday.

But all UK households lose from a depreciation that pushes up the cost of imported goods, raising prices in the shops and eroding the real value of their earnings and savings. Research published by the London School of Economics estimated that the spike in inflation that followed the 2016 referendum was costing the average household £7.74 a week — equivalent to £404 a year — by June 2017.

As Paul Johnson, director of the Institute for Fiscal Studies, wrote at the time: “If the value of the pound falls relative to the value of other currencies, that makes those of us whose earnings or savings or investment income is in pounds poorer. Period.”

The Bank of England estimates that a 5 per cent depreciation in sterling adds 0.9 per cent to consumer prices in the long term, with some of the biggest increases seen in food and energy bills, as well as the prices of import-intensive goods such as laptops, TVs and toys.

What about the boost to exports?

Currency depreciation no longer seems to help exporters as it did in the past. The slump in sterling that followed the 2008 financial crisis made very little difference to the UK’s trade balance. The post-referendum fall in the pound did even less: the Office for National Statistics found that exporters responded by putting up prices, rather than by expanding output. Meanwhile companies that rely on imported inputs have faced a sustained increase in their costs.

The small advantage conferred by the pound’s current weakness is unlikely to offset the bigger effects of an ongoing global slump in manufacturing and acute uncertainty over the UK’s future terms of trade.

Can the Bank of England do anything about this?

No. The forecasts in its August inflation report — to be published on Thursday — will probably show inflation rising above target in the medium term, with the overshoot worsened by the latest fall in the pound. But these forecasts have limited bearing on policy at the moment, because they do not take account of the growing risks of a no-deal Brexit.

If Britain does leave the EU without a deal, the inflationary effects of a weak pound and a likely loosening in fiscal policy will make it harder for the BoE to cushion the economy from the shock by cutting interest rates. But the central bank is very unlikely to make a policy move now when such radically different Brexit outcomes remain possible.



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