Powerhouse to Parity: The Crash of the £ and what it means for the future
The Historical Significance of the £
The pound was seen by many not just as a currency but a symbol of strength and haven for investors. But on Wednesday it skydived to its lowest valuation since 1971 of £1.0350 (in USD) the first time since the mid-1980s it has been considered the £/$ relationship could reach parity. This event characterises a decline that has been slowly eroding the position of the UK as a global economic superpower. Ian Goldin (professor of globalisation and development at University of Oxford) stated “It’s just a question of time before it [UK] falls out of the top 10 economies in the world”[1] after being leapfrogged by India and currently sitting 6th.
The depreciation of the pound might be a sound metaphor for the stumbling and stuttering of the UK economy, but it also represents real consequences for everyday people going forward, and the question on many people’s brains is how could this have been allowed to happen?
Why did this happen?
Quite simply, the Mini Budget.
More specifically, the proposed action by Kwarteng backed by the new PM Ms Truss. The “mini-budget” set out a plan to help boost the UK economy by cutting taxes to encourage spending and encouraging growth, aspiring to a 2.5% p.a. target.
Based on the introduction and the UK’s previously lagging growth rate p.a. (2% average between 2011-2019 [OECD database]) this seems like a stellar plan. However, against a backdrop of national debt at 94.9% of GDP, the highest since 1962 when the government was paying off debts accrued during WW2. Additionally, the current inflationary environment, slightly curbed by the freeze on energy cap increases but still forecasted to peak at 11% in 2023 Q1. Suddenly stimulating inflationary spending by cutting taxes and borrowing to bridge the gap doesn’t seem so bright.
Dario Perkins (MD at TS Lombard) said “The problem isn’t that the UK budget is inflationary, it’s that it was moronic”[1], aptly summing up the sentiment around the new PM and Chancellors plans.
This culminated in the £ sliding in value as experts deemed the plans for borrowing as implausible at a time when interest rates are going up increasing debt costs. With UK debt verging on unsustainable this has driven investors away from the £ contributing to the slide. This also creates a self-perpetuating cycle, to curb inflationary policies the BoE will likely hike interest rates higher than already intended increasing the burden of the debt costs and reducing faith in the UK’s ability to service the debt further.
What does it mean for the public?
Everyone’s bored of hearing about inflation but the devaluing of the £ only makes things worse on that front. The UK has been for a long time a net importer (more imports than exports) and the pound being worth less means imports will cost more. The top 3 most valuable imports to the UK 2021 were: Machinery and transport equipment, miscellaneous manufactures and material manufactures; now while we won’t see these items on our shelves these imports being more expensive hurt firms who will likely recover their margins by increasing prices to the consumer. The 5th most imported item was fuel (an overdone topic if ever there was one) but while we’ve seen a decrease from the peak in fuel prices in July the declining value of the pound could see this level return or even be surpassed.
The aforementioned interest rate hikes as a consequence of curbing inflation, will mean more value added to your savings but this will likely be surmounted by the increase in mortgage repayments. 1/5th of households are on variable mortgages meaning their repayments track the banks base rate and forecast have estimated repayments could double by next year.
Although were going into winter, bad news for those with any form of holiday in mind as the devaluing of the £ means you get less dollar, euro, yuan etc. for your money and if there is one thing that certain, it’s messing with the UK publics holidays is never a good political move!
Looking Forward
A dishevelled Rishi Sunak will currently be the smuggest man waiting to say I told you so, who on his eventually unsuccessful leadership campaign in August warned “There will be a run on Sterling. The gilt markets will be in freefall… before long Liz Truss and her new Chancellor Kwasi Kwarteng will have been forced to call in the IMF to stabilise a collapsing economy.”
But Truss and Kwarteng seem unphased by the reaction to their proposed plan as Kwarteng announced intentions to draw up and present the finalised plans in November promising even more tax cuts.
The future is uncertain, a statement many will be bored of hearing given the events of the past couple of years. Without a significant U-turn, an unlikely eventuality, what many experts have forecasted is likely to come to light. Unless Truss and Kwarteng have some cards hidden up their sleeves it’s unlikely that this all-in style call is going to pay off.
References/ Further Reading:
[1] Why the British Pound Continues to Sink - The New York Times (nytimes.com) [2] Why the British Pound Continues to Sink - The New York Times (nytimes.com)