Hard Times Ahead in 2017

A retired BoE Governor thinks Brexit is a good idea

mervyn-kingBoxing Day and a message from a retired Governor of the Bank of England.  See this report in the Telegraph: “Britain should be ‘confident’ about Brexit and quit Single Market, former Bank of England governor says”.   Lord King’s contention that Brexit will be good for the UK is open to serious question – not least because of his record as Governor. See this 2012 review of his performance in the Daily Mail: “CITY FOCUS: Our verdict on Sir Mervyn King’s reign as Bank of England governor

The financial crisis is the albatross that people will continue to hang around King’s neck. He has finally admitted the Bank could have done more in the build-up – ‘we should have shouted from the rooftops – and that ‘conquering inflation was not enough to ensure stability’. 

There was too much emphasis on monetary policy and not enough on financial stability. The Bank has bucked up its ideas after being caught on the hop, but the Verdict remains a miserable failure.

With that sort of record, the opinion of this former Governor is not one on which it would be wise to rely.

Cutting Immigration may be dangerous

The National Institute for Social and Economic Research has sought to estimate the financial impact of Brexit reductions in immigration:  see the NIESR Report “The Economic Impact of Brexit-induced Reductions in Migration”.   The Mirror has this: “Warning of long-lasting economic damage if 150,000 migrants are lost to Brexit – Research suggests that losing such a great number of migrant workers will reduce GDP per capita in 2030 by up to 5.4% below what it would otherwise have been”.

Planning for Brexit

The Financial Times has an interesting article about Brexit planning: “The remarkable Brexit blueprint from 2013 – A British diplomat wrote a paper three years ago — and it is striking how many of his insights are being proved correct”.     The report he refers to is available on the Web site of the Institute for Economic Affairs ( which is a right wing think tank):-  “A Blueprint for Britain: Openness not Isolation by Iain Mansfield”.

The FT’s James Blitz ends with this comment:-

I have not managed to speak to Mr Mansfield for this blog, despite trying to do so through FCO contacts. Perhaps my summary of his pamphlet is a bit kind. His vision of Britain emerging as an open and prosperous trading nation after Brexit is one with which many would disagree. Plenty of commentators believe the UK is heading for a train wreck in the forthcoming negotiations.

But Mr Mansfield’s essay is an impressive example of how a lone British diplomat was able to do some serious thinking about the consequences of Brexit some three years before the referendum happened.  It raises questions about why a few more people in Whitehall were not asked to do the same.

The Pound Buys Less

On 5th October 2016, the Wall Street Journal had this: “Pound Drops to Three-Decade Low Against Dollar on Brexit Concerns – Investors worry about the effects of U.K.’s departure from EU on the British economy“.

may99“The pound fell to a 31-year low against the dollar and has declined 1.9% over the past two sessions after U.K. Prime Minister Theresa May on Sunday set a March deadline to begin exiting the EU and indicated that maintaining its privileged access to the country’s largest trading partner was a lower priority than controlling immigration.  The U.K. currency has dropped 14% against the dollar and 13% versus the euro since the June 23 vote to leave the EU.”

On 22nd December 2016 the Financial Times gave an update on the depreciation of sterling: “Pound slide extends as Brexit overshadows sentiment – Currency falls for fourth consecutive day against the euro over economic fears“.

Our concern is that the market is too complacent and optimistic in its Brexit pricing as UK asset pricing seems to suggest the market is moving away from a hard Brexit pricing, with little concrete reason,” said Jordan Rochester, foreign exchange strategist at Nomura. Setbacks in economic data could push the euro higher against the pound to 88p and drop sterling below $1.20, Nomura strategists added.

UBS strategists said that recent sterling strength was likely to prove temporary. “We have argued that a Brexit-induced adjustment in the UK’s current account will necessitate further currency weakness,” said the bank, predicting that sterling would fall to parity with the euro.

The Telegraph had this on Boxing Day: “Brexit talks to rock pound as Article 50 marks sterling’s ‘final dip’“:-

The start of two years of formal Brexit negotiations with Brussels is expected to push the pound down by more than 5 pc against the dollar and euro from current levels of $1.2290 and €1.1764, according to Bank of America Merrill Lynch (Baml), Morgan Stanley and Deutsche Bank… Oliver Harvey, a currency strategist at the bank [Deutsche Bank], said sterling could plunge to as low as €1.03 against the euro, which would be the lowest since the end of 2008.

Impact on UK Households

Some time ago, the Government published a computation of the likely impact of sterling depreciation on household spending:  “The impact of a sterling depreciation on the costs of a family shop on food, nonalcoholic drink, clothing and footwear“.

It concluded that a 12% fall in the value of sterling leads to a 2.9% increase in the cost of food and drink and a 5% increase in the cost of clothing and footware. However, more recent research suggests the reality many be worse.  See this July 2016 report in the Financial Times: “Harsh realities of a weakened pound – Sterling’s malaise set to hit households harder than they expect“.

A weaker exchange rate will raise certain domestic prices rapidly. Petrol and air fares, where costs are denominated globally in dollars, are obvious examples where prices are already on the rise. The prices of imported fruit and vegetables, tobacco and even books have also been sensitive to sterling in the past.

But the overall relationship between higher import prices and inflation is uncertain. Traditionally, the BoE had a rule of thumb that about 60-90 per cent of the drop in the exchange rate would be felt in higher import prices. An 11 per cent depreciation in sterling’s value, therefore, should add 2-3 per cent to prices over a period of time.

In summary, Brexit has unleashed a different sort of currency depreciation, according to modern economics, one that is less likely to encourage domestic investment for exports, is more likely to raise inflation and will be more painful for hard-pressed families.

As David Miles, a former MPC member, told MPs soon after the referendum: “I am not terribly optimistic that, if sterling now stays at the current level, we should expect a marked increase in exports from the UK and a significant reduction in the current account deficit.

Stephen King, adviser to HSBC, added that if exports were not significantly stimulated, sterling’s fall would have the effect of raising prices faster than wages, thus cutting living standards. “This is when you get into the whole risk of recession, stagnation and income squeezes of one sort or another,” he added.

On 23rd December 2016, the Guardian had this: “Business as usual for UK economy – but where will it go in 2017? – Revised GDP growth figures show Britain putting in a solid performance – but inflation could lead to a slowdown“.

Hard Times Ahead

The likely prospect for the coming year is that the political uncertainty stemming from the referendum will continue to deter investment. Growth is expected to decelerate in 2017 amid a slowdown in real household income growth.

Price increases for foreign travel, fuel,  food and clothing resulting from falls in the value of the pound will have a negative effect on most households.

The hardest hit will be the elderly, the poor and Teresa May’s “Just About Managing” families.

 

 

 

 

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