Pound’s Safety-Valve Status in Jeopardy

The pound risks turning from prop to pain for the UK economy as Brexit negotiations near.

Sterling tumbled the most last week since the vote to leave the European Union in June, as investors woke up to the fact that the UK government’s approach to Brexit may mean forgoing access to the single market. While the currency’s weakness has helped cushion the economy in the immediate aftermath of the referendum, the latest slide may carry more costs than advantages, Bloomberg reported.

The drop caused companies to downgrade profit forecasts, threatened to fan inflation, and also hinted at a further fall from grace for what was once the global reserve currency. The flash crash last week was more redolent of a frontier currency than the world’s fourth-most traded, and only Sierra Leone’s leone and the Mozambique metical have dropped more than the pound since the June 23 referendum.

While a weaker currency can give exporters a boost, those advantages can disappear when the slide is as fast and disorderly as sterling suffered last week, according to Nomura Holdings Inc. The pound’s 16% tumble against the dollar since Brexit may be part of a fundamental shift in the state of the UK economy that monetary policy alone can’t tackle, former Bank of England policy maker Adam Posen said on Friday.

  Economic Impact

“It’s really a question of pace as much as a level,” said Bilal Hafeez, global head of foreign-exchange research at Nomura in London. “The key thing is the need for more stabilization, or less sharp moves. But if it continues at this pace it could have a negative feedback loop.”

The impact of the declining pound has been filtering through since the vote. Manufacturing has been supported by a weaker sterling, the exporter-heavy FTSE 100 index approached a record high, while import prices have jumped. As the plunge accelerated during the ruling Conservative Party’s conference last week, the wider fallout became apparent.

The disruptive impact from a sudden currency depreciation may be so large that it exceeds the economic benefits that accrue from higher exports, according to Commerzbank. For consumers already noticing the higher cost of foreign travel, the risk is that a weaker currency results in price rises at home, while faster inflation may make it less likely that the Bank of England will be able to support a slowing economy via lower interest rates or more asset purchases, increasing the risk of stagflation.