The UK government this week found that taking back control of some things is a lot harder than others. The pound sterling falls into the former category. The currency fell to a trade-weighted level last seen in the middle of the 19th century.
For some optimistic Brexiters, events reflected the pound dropping to a more competitive level, promising a re-balancing of the UK economy and a reduction in its large current account deficit. But as this week’s Marmite spat between Unilever and Tesco showed, the effects of international supply chains can have unfortunate effects: rising import costs affect not only consumers but intermediate users of imported goods and services.
The decline in sterling, in a country with a free-floating currency, is not a crisis. But it does suggest investors are re-rating the competitiveness of an economy whose government appears bent on harming the industries in which it has comparative advantage.
As far as one can tell - and the foreign exchange markets are not always known for clear logic - the fall in sterling was a reaction to Theresa May’s government signalling a desire for “hard Brexit”, including no longer being a member of the EU single market. That would hurt the UK’s financial services sector, which relies on regulatory “passporting” arrangements to operate freely across thebloc.
That move, plus the lack of clarity surrounding the government’s strategy, has contributed to uncertainty about the UK’s handling of Brexit. This probably also played a role in the fall of the currency. Certainly the rise in gilt yields that accompanied the slide in sterling most likely reflected an increase in risk premium.
The optimistic view is that a weaker currency will enable other parts of the economy, especially the manufacturing industry, to compete better with imports and to find new export markets. Recent history, though, is unpromising. The fall in sterling that followed the global financial crisis, although it imported higher prices, had little of the hoped-for effect on the trade balance. Demand at home and abroad did not react much to the change in prices, and depreciation had the effect of holding down real wage and consumption growth at home more than boosting exports.
The tussle between Unilever and Tesco over the pricing of goods, including the yeast-based spread Marmite, is a case in point. British consumers may have been puzzled that a product largely made and consumed in the UK should be affected by currency movements. But being owned by a Dutch-headquartered company, which reports in euros and uses imported packaging and machinery, means even the most British of products is not immune to exchange-rate movements.
UK businesses reliant on imported inputs - the British car industry, for example, is part of a complex international supply chain - are likely to find that a weaker currency has serious downsides. Small businesses are at risk. New export industries with price-sensitive goods may arise to replace the lost sales of financial services products, but that is an uncertain and long-term proposition. In the meantime, the fall in sterling will push up prices, eat into real incomes and make Britain poorer.
In these circumstances, it is hardly a surprise that investors are marking down the UK’s economic prospects by selling its currency. The government says it will not provide a running commentary on Brexit ahead of next year’s negotiations with the rest of the EU. But the faster that Mrs May’s government provides some clarity about exactly what it is aiming at the better.
