Pound sterling: UK’s trade-weighted currency index slumps to historic new low on hard Brexit fears

The Sterling Effective Exchanage Rate Index is now at its lowest level on record – below the 2008 financial crisis nadir and also the 1993 trough in the wake of Britain’s ejection from the Exchange Rate Mechanism

Ben Chu
Economics Editor
Wednesday 12 October 2016 18:27 BST

An important measure of the value of the pound has dipped to its lowest level on record amid fears among currency traders and investors that the UK is heading for a hard Brexit.

The Bank of England reported that the sterling Effective Exchange Rate Index (EERI) – a measure of the value of the pound that is calculated according to how much trade we do with different countries and in various currencies – fell to 73.8 on Tuesday, down 0.55 per cent on Monday.

This largely reflected Tuesday's steep sell-off of sterling against the dollar and the euro – prompted by signals that the UK is on course to leave the single market by 2019 and possibly without a free trade deal with the rest of the EU in place by then.

That slippage took the EERI to its lowest level on record ~ dipping below the 73.5 nadir during the 2008 financial crisis and also the 73.6 trough in 1993 in the wake of Britain’s ejection from the Exchange Rate Mechanism.

All-time low

Bank of England
Bank of England

The EERI is weighted according to the UK's bilateral trade flows, with the US currently accounting for 18 per cent, China 9.3 per cent and the euro area 48 per cent.

In total the EERI covers 21 countries and the series goes back to 1975.

The modern era of free-floating exchange rates began in 1973, following US President Richard Nixon's decision to take the dollar off the Bretton Woods gold-exchange standard.

Bank of England economists and policymakers pay a good deal of attention to the EERI because it represents a broad snapshot of the competititivess of UK industry and possible future import price pressures, containing more information than individual bilateral exchange rates such as the pound versus the dollar or versus the euro.

Sterling recouped some of its losses on Wednesday, ending up around 0.73 per cent against the dollar at $1.22 on the back of a pledge by Theresa May that she will alow a House of Commons debate before Article 50 is invoked next year.

Against the euro the pound also rose 1 per cent higher to €1.10.

But against the dollar sterling remains 18 per cent lower than on 23 June.

And against the euro the pound is 15 per cent down.

The EERI, as of yesterday, was down 15.5 per cent since the referendum.

Most economists argue that the plunging value of the pound is a negative verdict on the UK economy's prospects, signalling financial markets expect the UK will grow less as a result of leaving the EU.

They also expect the fall in the value of the pound to push up domestic prices, imposing a real-terms squeeze on household incomes,

However, some, such as the former IMF economist Ashoka Mody and the former Bank of England Governor Lord King, have argued that sterling was overvalued before the referendum and that the rapid correction will help the UK economy rebalance, not least by boosting exports by making UK goods and services instantly more competitive in global markets.

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