Chris Johns: Sterling vulnerable as hard Brexit looms
As Britain moves towards exit talks, the UK currency is in the firing line
British prime minister Theresa May: she just seems to want to kick things into the long grass. Photograph: Hannah McKay/PA Wire
The best indicator of whether Brexit is likely to be “hard” or “soft” is sterling. And the harder it is, the more we will be affected. Next month will see the first “Brexit budget” to be introduced by an Irish Minister for Finance: it almost certainly will not be the last.
One the eve of the EU referendum, €1 could buy roughly 76.5p of the UK currency. In the few days that followed, the rate soared to 86p – even by the volatile standards of the foreign exchange markets, that was a big move. In the old days we would have called it a devaluation.
In even older days, it would have been described as a sterling “crisis” with the direct implication that the UK authorities had to do something about it. Today, it’s not a crisis because we know the Bank of England is more than happy to accommodate a lower exchange rate – and not just against the euro. Sterling has fallen by similar amounts (if not more) against the dollar and other major currencies.
Since then, sterling’s fortunes have ebbed and flowed but the pound hasn’t really gone anywhere. A small recovery through July was subsequently reversed in early August, mostly due to an absence of hard news and a general, but short-lived, rise in the euro against all currencies.
The second half of August saw the UK currency regain a little ground as the first pieces of post-referendum economic data began to come in, suggesting the much feared economic crash had yet to occur. Things were helped by the steady hand of the Bank of England: the calm but forceful way it dealt with the financial market fallout of the referendum served to remind investors that at least some adults were still in charge of UK policy.
During September it has been instructive to observe the pound start to weaken again, notwithstanding a continuation of the relatively positive news flow about the UK economy. We have yet to breach in any sustained way the immediate lows seen after the referendum but we are getting close. While all the main protagonists in the Brexit negotiations are understandably playing their cards close to their chests – to the point where they continue to pretend there are no talks of any kind taking place – all the early signs are that it is going to be a pretty hard exit.
What will that hard exit look like? Most obviously, it will involve leaving the single market. The implied need to negotiate a host of new trade agreements with the rest of the world is why economists get worried about what uncertainty and delay could do to the economy, particularly investment. In such circumstances, the City of London would lose its much vaunted “passporting” rites and the only bit of the UK economy that is actually world class (the rest is mostly average to mediocre) would inevitably be damaged. It is impossible to say by how much, such is the level of uncertainty.
The conclusion that it is likely to be a hard exit has followed on from various public pronouncements from the three Brexit ministers – Liam Fox, David Davis and Boris Johnson – who all seem to favour precisely this outcome. This prompts financial markets to shift attention away from the Bank of England to the school playground that used to be known as Whitehall. And this is when sterling starts to weaken again.
The moves in the pound haven’t amounted to a big deal – yet – because of the suspicion that much of this is, in fact, negotiation. Indeed, the UK government seems to be negotiating with itself, since every time Fox, Davis or Johnson open their mouths, they are immediately handed a public rebuke by the prime minister Theresa May. The three Brexit ministers all seem to want a quick, not just hard, Brexit. Ms May, by contrast, just seems to want to kick things into the long grass.
All of this is mildly corrosive. Hence the ongoing weakness of sterling, but without any real fireworks. The main action will come when the two-year countdown to Brexit begins on the day Ms May sends the Article 50 email to Brussels. By then, given the way these things are already playing out in public, we should have a good idea about the nature of the UK’s exit. A deadline always concentrates the mind.
It remains possible that the faint whispers of a compromise between the principle of the free movement of people and access to the single market become louder. In which case, sterling will rise. But this seems highly unlikely right now.
Even if this happens, the phrase “Brexit compromise” or, heaven forbid, “soft Brexit”, will probably tear the ruling Conservative Party apart, perhaps even leaving the way clear for a renaissance of a Corbyn-led Labour Party.
Sound advice from market professionals is never forecast, particularly when it comes to exchange rates. But there is little in all of this for the foreign exchanges to like – and no good news for Irish exporters under pressure from sterling weakness.