‘The old UK growth model is dead’: What a long-term weak pound means for Britain

LONDON — The British pound’s exchange rate against the U.S. dollar

has been on a rollercoaster ride in recent months.

After a year of steady decline, it plunged to an all-time low beneath $1.10 after the U.K. government’s infamous “mini budget” in late September. It then recovered to $1.16 after the country swapped its finance and prime ministers in late October; and sank to $1.11 after the Bank of England downplayed rate hike expectations and warned the U.K. had already begun its longest-ever recession on Nov. 3.

The recent highs and lows have all played out within a range that sterling has not traded at against the greenback since 1984. In mid-2007, at the precipice of the financial crisis, it was possible to get two dollars for a pound. In April 2015, it was still worth $1.5; and at the start of 2022, $1.3.

Almost all currencies have declined against the dollar

this year, and sterling’s depreciation against the euro has not been as severe given the European Union’s own challenges with economic slowing and energy supply.

But the euro is still much stronger than it was against the pound in the 1990s and for most of the 2000s; and the pound’s global importance has evaporated since the days when it was the world’s reserve currency in the early 20th century.

A historically weaker pound on a medium- to long-term basis has a variety of impacts on the U.K. more broadly, economists told CNBC.

The most basic one is that imports get more expensive, while exports theoretically get more competitive.

“The problem is that the UK is very import dependent, almost two thirds of food is imported, so a ten percent decline in the real effective exchange rate really translates quickly into higher food prices,” said Mark Blyth, professor of economics and public affairs at Brown University.

“The UK is a low wage economy. That will hurt.”

Long-run situation

Richard Portes, professor of economics at the London Business School, also noted the U.K.’s reliance on foreign trade, which means a “significant” impact on prices from a weaker currency, though he said there was not yet evidence of a significant effect on U.K. demand for foreign goods — but nor was there on exports, which theoretically become more competitive.

He also noted currency depreciation had a level effect on prices rather than being inflationary.

“It’s a one-off effect. It’s not necessarily giving us inflation in terms of a continuous rise in the price level,” he said. “If it contributes to a wage price spiral then that is inflationary, and that’s what we’re all concerned about now. We don’t what to see these price increases which have come about partly because of Ukraine and so on, we don’t want to see wage rises that will trigger price rises and spiral.”

Sterling’s depreciation is a long-term trend since it was allowed to float freely in 1971, he said, telling CNBC: “I think it’s reasonable to expect that to continue. And that’s partly because productivity and therefore competitiveness has not been very good relative to our trading partners. So that’s the long-run situation.”

The U.K.’s current account deficit (which is where a country is importing more goods and services than it is exporting, and stands at £32.5 billion for Britain) is financed by capital inflows, he noted. Former Bank of England Governor Mark Carney has said the U.K. is dependent on the “kindness of strangers.” But Portes said “it’s not their kindness, it’s them wanting to invest because they find their projections and possible yields, investors find U.K. assets sufficiently attractive to bring in capital.”

“If they find it less attractive, U.K. assets would fall in value to induce people to invest more, so the exchange rate will fall further. That depends on confidence in the British economy, fiscal policy and all those things.”

But, Portes said, the weaker pound is not in itself an issue for the fiscal planning the government is currently doing, with a much-anticipated budget due Nov. 17.

“If a lot of our debt were denominated in foreign currencies it would, but it’s not. Our public debt is denominated almost entirely in sterling. And so unlike some countries, we don’t find it a problem. I don’t think the depreciation we’ve seen or that is likely over the next few years will make much difference to fiscal positions.”

‘Growth model is dead’

According to Blyth, beyond the pain suffered by households, the higher prices caused by a weaker currency will have deeper and longer-lasting effects.

“The U.K. is a heavily consumption-based economy, and such a shift is equivalent to a tax on consumption. That means less fuel in the economic engine. The U.K. already has low growth and even lower productivity growth.”

The potential upside to exports was negated by Brexit, he said, pointing out that the U.K. economy had declined from 90% to 70% of the size of Germany’s since the 2016 vote.

“So what does this mean long term? It means that the old U.K. growth model is dead,” Blyth continued.

“Financing your consumption from other peoples’ savings (capital imports) and swapping overpriced houses had a shelf life. It’s passed. The combination of a structural fall in the exchange rate plus positive inflation ends it.”

The appeal of cheap British assets only held if they were going to be revalued, he said, and “GBP is not the USD. Period.”

Adjusting to this new reality will be painful but necessary for the long term, Blyth believes.

“A U.K. that is not dependent upon greater London generating 34% of GDP, with the north and west living-off transfers, is a better U.K. It will just take time, imagination, and investment to get there.”

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