Sterling: off the cliff

22 November 2016 | Markets and Economy


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Leo Schulz: 'Sterling: off the cliff.' Since the UK voted to leave the European Union on the 23rd of June, the value of sterling has fallen heavily. My name is Leo Schulz, and I have with me Peter Westaway, Chief Economist and Head of Investment Strategy at Vanguard Europe. Peter, why such a strong fall?

Peter Westaway: Well, you're right to say that there has been a strong fall. Sterling's fallen by about 20 percent across a range of currencies. That's comparable with the falls that we saw at the time of the great financial crisis in 2008. And one of the main reasons that it's fallen so much is that because of the shock from Brexit, there's an expectation that activity will be weaker, and as a result, the Bank of England have loosened their monetary policy. So they've cut interest rates from 0.5% to 0.25%; they've announced more quantitative easing, and both of those measures have the effect of weakening sterling relative to other currencies.

Leo Schulz: It's not all monetary policy though is it, Peter? Trade policy – we can see that fat red line there which is the Brexit vote, and we can see that sharp fall. Trade policy is deeply involved here, isn't it?

Peter Westaway: Yeah. I don't think you'd get a fall as big as this if it was just about interest-rate expectations. Because of the nature of the UK leaving the EU, it's likely to mean that the UK's trading relationships with the EU and maybe with other countries are going to deteriorate, and as a result of that, effectively the exchange rate needs to fall to compensate for that deterioration, and so it's sort of an equilibrium shift.

Leo Schulz: Is it going to be the case that sterling is going to be like a barometer that's going to swing backwards and forwards with every twist and turn of the Brexit negotiations?

Peter Westaway: Yeah, I think that's what has been happening, and I think it's not unreasonable to think it will carry on like that. I mean, it's really all about whether or not we think the UK are going to end up with a hard Brexit; that would be one where we end up leaving the European single market, or whether we have a soft Brexit, which means our trading relationships are perhaps not damaged as much. And depending on which of those two outcomes occur, the exchange rate responds accordingly.

Leo Schulz: On the fact that the UK economy has done a bit better than expected, how much of that is residual momentum and how much of that do you think might be exchange-rate-related?

Peter Westaway: It's really difficult to say because I think the exchange rate has fallen more than expected and so that's helping to buoy up the economy. Policy's provided some stimulus, and yes, it might just be because of the growth before the vote. There's a lot of moving parts here and at the moment this is just all adding to the uncertainty in the post Brexit world.

Leo Schulz: Improved export price competitiveness should help to limit how low sterling can fall, but expect plenty more volatility before the dust on Brexit settles. Peter Westaway, thank you very much.

Peter Westaway: Thank you.

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