Sterling has been on a downward trend for some time, as have many other currencies around the world. The catalyst for this has been the relative strength of the Dollar.
The weakening in the value of Sterling at the beginning of this week was more specific to the UK. Kwasi Kwarteng’s Mini-Budget on the 23rd September marked a significant change in fiscal policy in the UK. The decision by the Truss Government, to borrow to cut taxes, in a manner we have not seen for nearly 50 years, is undoubtedly a bold attempt to stimulate growth but is also potentially very risky at this stage of the economic cycle. The timing of the taxation changes, when the economic situation is so volatile, have to be questioned. Against a backdrop of decades high inflation and rising interest rates, never mind an energy price crisis and war in Ukraine, there could have been a more stable time to make such significant changes to taxation policy. Foreign investors have made their views clear, as has been seen by the pressure that Sterling has come under over the weekend and into this week. The fiscal measures detailed in the mini-budget were not supported by a coherent funding strategy that lays out how the Governments finances will be balanced over the cycle and that miscommunication has certainly added to the pressure that Sterling is under. The perception from many Economists is that moving to a low taxation growth strategy at this time is a gamble.
The implications for the real economy of the fall in Sterling are that interest rates will in all likelihood have to rise further than previously anticipated, possibly as high as 6%, which will have a direct impact on borrowing costs for individuals and companies. The relative weakness of the Pound will potentially make inflation more stubborn as imports into the UK from abroad will become more expensive. On the positive side, UK companies that export their goods will benefit from the weaker Pound as their goods will be comparatively cheaper for foreign buyers. UK companies that earn in foreign currencies will benefit from the conversion impact of a weaker Pound.
Over the last couple of days much has been written about the possibility of Bank of England intervention by raising interest rates before the next scheduled meeting of the Monetary Policy Committee (MPC) on the 3rd of November. Albeit the MPC are independent of the Government there would normally be some form of coordinated action agreed upon to ensure that there is no misalignment in policy that could increase market perception of instability. Whether this takes place or not is too difficult to call at this moment as there are differing views on the merits of intervention either being perceived as a panic reaction or a sensible way to calm markets. Time will tell what actually happens.
The fall in Sterling has not jumped from being a financial problem to a consumer problem as yet. The value of the Pound when going abroad on holiday will be noticeable but not significantly so, unless you are going to America. Oil is priced in Dollars but the Oil price has been falling as demand falls. The cost of servicing existing borrowing will be the most noticeable change, unless you are on a fixed rate deal.
Fundamentally the economic background has not changed significantly. A global recession is still a genuine risk, but this has been the case for the last few months.
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