By Colin McLean
Until recently, most of us gave little thought to currencies. Apart from foreign travel, pounds were all that mattered for day-to-day life.
Suddenly, it is clear just how much the UK imports, much denominated in US dollars.
Is it possible for the UK to adjust to the pound’s collapse?
This is just the sixth and latest currency crisis in the post-Second World War period, starting with Suez in 1956 and reflecting the decline in British economic importance globally.
Mostly, the market gets it right when it sells the pound. Over the years, there has been failure to fully grasp the potential for exports and import substitution. Britain lags in energy security and has been a significant food importer for most of the last century.
British policy looks more like Italy’s repeated devaluations to regain competitiveness. Even joining the euro has not stopped Italian crises.
The pound’s weakness has reshaped the Scottish and UK economy. For a trading nation such as the UK, with an open economy, the pain will quickly be transmitted to UK businesses and consumers, likely limiting further freedom of action for the Government. A jump in interest rates is likely soon, no matter how calm
the initial Bank of England reaction was. Whether or not the UK Government pays heed, international financial markets have passed judgment.
Fears have been raised of a UK debt crisis. However, almost all of the British national debt
is in pounds, and this should mean that UK default on its borrowings is avoidable, although the result will be high debt costs, a weak currency and lots more money printing. On data from the International Monetary Fund, the
UK has the second-lowest ratio of public debt to GDP in the G7; Germany is lower, but France, US, Italy and Japan much higher. The pound is in line with where it stood against the euro five years ago, in the aftermath of the Brexit vote.
Devaluations usually act as a correcting mechanism if there is sufficient business confidence to boost exports and import substitution. British consumers will also be forced to make hard choices in terms of their spending; although some imports are living essentials, rising prices in imported manufactures and foreign holidays will force substitution of discretionary items. The lower pound will attract tourists, but that takes time.
All UK households face a big cut to real income; discretionary spending power will fall. Shares exposed to British consumers are likely
to be particularly hard-hit.
Many London-listed shares are global businesses, with earnings in US dollars and
other currencies.
Oil and gas, commodities and pharmaceuticals are notably overseas earners, although even many of these have fallen after the mini-budget. That may be reversed.
In recent years, and particularly following the Brexit vote, many investors have rebalanced their portfolios to reduce investment in British shares and move much more overseas. Many international investors have simply left. It does mean that even although most London-listed shares have international earnings, more investors now can access these currencies and earnings streams directly in foreign markets.
Part of the record currency move for the pound is represented by the strength of the
US dollar itself. It does look as if the US
economy is going through a more normal business cycle, with the US Federal Reserve tightening in a typical and proven way. The
euro has fallen to a 20-year low against the dollar, showing that the UK is not the only problem.
Ahead lies a critical period for the pound and more pain for consumers and British industry.
In recent years, the UK has nurtured a reputation for prudence in financing, but international investors are now questioning this.
Stabilising the currency and gilts may need
a medium term plan for fiscal responsibility to
be published.
Colin McLean is managing director of
SVM Asset Management.
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