Some very useful exchange rate info here - it is much more than a question of moving interest rates around:
Bank of America is wrong about the weak pound
The story so far is essentially one of dollar strength, rather than sterling weakness
Jamie Dimon, boss of JP Morgan Chase, thinks an economic hurricane is coming. Announcing a one in ten headcount reduction at Tesla, Elon Musk says he has a “super bad feeling” about the economy. John Waldron, chief operating officer of Goldman Sachs, warns that markets have yet to come to terms with the current, unprecedented confluence of economic shocks.
Amid it all, the UK is said to be in a particularly difficult position. So claims Kamal Sharma, foreign exchange strategist at Bank of America. International investors are increasingly of the view that the pound sterling has taken on emerging market characteristics, he warns.
I’m not sure about Dimon’s hurricane or Musk’s “super bad feeling”. Perhaps they are right, though it is worth noting that both these pundits are quite late to the party. Predictions of catastrophe have been the presiding narrative for some months now, and it hasn’t happened yet.
But I do take issue with the idea that the pound is about to undergo some kind of fundamental repositioning that destroys its remaining reserve currency status.
This is not to argue it’s impossible. There have been many such moments of currency reappraisal in Britain’s long retreat from empire.
In 1931, just before Britain abandoned the gold standard, a pound would have bought you 4.87 US dollars. Immediately afterwards, your pound was worth a considerably reduced but still respectable $3.69. Unfortunately, that was just the beginning. The next big devaluation was in 1949; this was a whopper which reduced the value of the pound by around 30 percent and essentially marked the end of sterling’s reign as the world’s pre-eminent currency for international trade
Against this, Harold Wilson’s famous “pound in your pocket” devaluation was a comparatively minor event - “just” 14 percent to $2.40. After that came the collapse of the Bretton Woods fixed exchange rate regime in the early 1970s, when there was another stomach churning downward lurch. All of these post war devaluations reflected an increasingly harsh reality — that the British economy was progressively losing international competitiveness, resulting in repeated balance of trade crises.
Just to bring things up to date, there have since been three standout such moments - the ERM debacle in 1992, the financial crisis in 2008/9, and the vote for Brexit in 2016.
The position has been relatively calm since the last of these episodes, with the pound bouncing around within a quite narrow range of about 10 percent against both the dollar and the euro. Until the beginning of this year, that is.
Since then, the pound has been the world’s third worst performing major currency, after the Swedish krona and the Japanese yen. There is obvious potential for things to turn uglier still. All the same, the story so far is essentially one of dollar strength, rather than sterling weakness. Against the euro, the pound has lost only a couple of cents, and the trade weighted index is actually marginally up on the year.
This is not to lightly dismiss Bank of America’s analysis, which raises important concerns about sterling’s continued credibility as a reserve currency. Obvious failings in the Bank of England’s inflation targeting regime have left policymakers in the invidious position of having to raise interest rates into a fast slowing economy — never a great look and often symptomatic of a downward spiral in the currency.
As Bank of America’s Sharma points out, this makes the Bank’s position notably different from that of the Federal Reserve in the US, which is raising interest rates against the backdrop of a still strong economy. Rightly or wrongly, there have also been questions over the Bank of England’s independence. Too often it seems a creature of the Government’s need for deficit financing.
But the Bank’s credibility is just the half of it. Since Britain left Europe’s single market, there has been a notable deterioration in the country’s external trade position, bringing back memories of previous balance of payments crises.
Even a widening trade deficit doesn’t really matter provided there is sufficient in the way of capital inflows to finance it. But if these start to wane, then the currency is going to be in some difficulty.
Throughout much of last year, when there was a general perception that UK assets were undervalued by comparison with peers, this wasn’t much of a problem. The money flowed in as required, and the exchange rate actually appreciated somewhat.
But this undervaluation may now have gone, and with rising interest rates more of less everywhere, UK assets may have lost some of their comparative appeal.
Global liquidity conditions are deteriorating, and with interest rate normalisation, net cross border flows have slowed. With such a large current account deficit, Britain is particularly reliant on “the kindness of strangers”, and therefore vulnerable to any loss in international confidence.
All this is no doubt true. Brexit has made trade with Europe, still the UK’s largest external market, more difficult and costly, while the UK Government has so far failed to demonstrate meaningful economic gains to compensate.
The Government’s refusal, moreover, to acknowledge that Brexit has played any part in deteriorating trade only further inflames the situation, making it look as if ministers have their heads buried in the sand.
But here’s where it is reasonable to take issue with the Bank of America analysis. All things are relative in currency markets, and looking around the world today, you would struggle to find a jurisdiction where things look notably better.
Run by an indecisive geriatric, paralysed by an increasingly dysfunctional political system, and torn apart by the poison of its culture wars, the US seems of ever less appeal beyond its traditional reserve currency attributes.
The EU? Slow moving and severely compromised by its 27 moving parts, it is more exposed than any to the debilitating effect on energy prices of the Ukrainian war. Besides, with rising interest rates, the eurozone debt crisis will be back before we know it. Spreads are already widening worryingly.
As for China, what on earth is the regime playing at? The anti-Western rhetoric alone would be enough to deter all but the bravest of investors. Add in the zero-Covid debacle, the crackdown on tech, on the education sector, on Hong Kong and on the Uighurs and you’d reasonably conclude that China’s economic miracle is over.
In any case, set against the alternatives, the UK doesn’t seem such a bad place for your money. Witness the great outpouring of affection for the monarchy, its institutions still seem relatively robust, and although the fiscal position looks precarious, it is by no means beyond redemption.
There is admittedly no discernable strategy behind the current chaos of intellectually bankrupt policy making, but that seems to be the case more or less everywhere. Can it really be that difficult for a Tory Government to provide the pragmatically driven and predictable policy framework that is required for enterprise to thrive? Sort that out, and so would sterling.
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