The mysterious drop in the pound last night isn’t our biggest problem – the problem is what made it happen

Last night’s plummet might have been the work of a rogue trading alogrithm. But the sizeable step downward shift since the Brexit vote feels like a cold-blooded market verdict on the UK’s future economic prospects out of the European Union

Ben Chu
Friday 07 October 2016 14:25
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Whatever the caused sterling’s mad 6 per cent plunge and sudden recovery, the bigger picture is worrying
Whatever the caused sterling’s mad 6 per cent plunge and sudden recovery, the bigger picture is worrying

Was it a “fat finger” error by a clumsy human trader? Was it a rogue computer algorithm? A devious bit of market manipulation? The truth is we may never know.

Analysts are still struggling to explain the “Black Monday” stock market crash of October 1987, when the price of shares around the world collapsed as much as 20 per cent for no apparent reason.

But whatever the precise causes of the pound’s mad 6 per cent plunge and sudden recovery in trading late last night, the bigger picture is clear: the pound is heading down.

How the pound has struggled since Brexit

This week alone the UK currency has slipped almost 4 per cent against the dollar, following from the 10 per cent decline in the immediate aftermath of the Brexit vote. What does it mean though?

The fact that overseas holidays become more expensive with each lurch downwards against the dollar and euro is now pretty well understood; so is the fact that a cheaper currency gives an immediate fillip to the UK’s good exporters by making their wares more competitive in global markets.

But some of the larger economic implications are still difficult to grasp for many people.

“In essence, the currency markets are saying that all UK assets are worth less than they used to be. Land, property, companies, bank deposits, government debt – everything in the UK has been marked down against the rest of the world,” argues Rupert Pennant-Rea, an asset manager and former deputy governor of the Bank of England.

The US economist Tyler Cowen has attempted to put a figure on the size of the markdown of the UK’s wealth and comes up with £360bn, or about £5,625 per person. That is about 19 per cent of Britain’s 2015 GDP. “Much costlier than a typical recession,” notes Cowen.

These kinds of calculations have their value – but should not be taken too literally.

Between the beginning of 2013 and the middle of 2015 the trade-weighted value of sterling climbed by 20 per cent. Yet there was little commentary over that period about the booming value of Britain’s national assets relative to those of the rest of the world.

Rather like with media commentary on the daily movements of the stock market, billions of pounds always seem to get “wiped off”, never “wiped on”.

And some serious economists, including the former Governor of the Bank of England Lord King, argue the value of the pound is now much closer to where it ought to be to help stimulate UK GDP growth and ease a rebalancing of the economy.

It is true that the UK’s yawning current account deficit will almost certainly close somewhat in the medium term as the value of the returns on foreigners’ financial assets in Britain automatically fall due to the sterling depreciation, and the returns on the financial assets of British households and companies held abroad automatically rise.

And markets – whose movements are the result of decisions made by tens of thousands of fallible investors and overexcited traders – can sometimes overshoot. We cannot say with absolute certainty that those pro-Brexiters who argue that sterling will pick up over the next few years are wrong.

Yet the fact that the “news” driving sterling down this week was caused by Theresa May signalling that we are heading for a “hard” Brexit and exit from the single market suggests that this movement cannot be dismissed as a paroxysm of market illogicality.

What happened to sterling last night was probably a blip. But the sizeable step downward shift since the Brexit vote feels like a cold-blooded market verdict on the UK’s future economic prospects out of the European Union. And it’s not a positive verdict.

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