The curious case of the pound that went up in the fight

When the UK voted for Brexit currency dealers panicked, started dumping the pound and its value dropped 15 per cent against the dollar. Till now forecasters have almost unanimously thought that Brexit would be bad for the economy and they were right. They started downgrading Sterling forecasts and one, Deutsche Bank, predicted a further fall of up to 16 per cent during the Brexit negotiations, as it becomes clear that there is not enough time to negotiate trade deals before the pain of leaving the EU single market comes home to roost.

Deutsche Bank predicted it could go as low as $1.05, but Jim Rogers the American investor and co-founder of the Quantum Fund, went further warning that the pound could even drop below the dollar within three to four years if Scotland were to leave the UK as result of a hard Brexit.

However, since Theresa May announced the snap General Election sterling has rallied somewhat, climbing 2.7 per cent on the announcement; this takes some investigation to understand why. Essentially sterling traders like stability, and a stable government with a large majority usually means no nasty surprises or policy changes. As the investors see a larger Tory majority as a mathematical certainty they expect sterling to rise. They also believe that the Conservatives, who had a small working majority of 12, but 20 sitting Tory MPs falling into the fundamentalist EU hate brigade meant that the PM was being held hostage by the hard Brexit mob. They hope that with a 100 majority she can ignore them and go for a softer Brexit with a stronger negotiating position.

Last year, however, 60 Conservative MP’s signed a petition backing leaving the single market and so the idea that a hard Brexit is only supported by a small minority in the party is clearly wrong.

Their reasoning is that May was for Remain, even though she didn’t campaign, and frankly she is pretty much not campaigning again in the General Election so no change there. They think that turkeys don’t vote for Christmas, so she will show her true colours when she is able to command a soft Brexit majority.

It’s an appealing rationale for the markets but it’s complete hokum. Theresa May is not campaigning for the benefit of the UK economy but for the benefit of her party. She is in fact seeking a mandate for the hard Brexit the markets fear.

So the pound will likely perform well for the next few weeks, wobble as the Brexit pre-negotiation spin from both Westminster and the EU turns nasty, jump when she gets an enhanced majority of more than 60, and then crash again after she announces that now she can go for a hard Brexit without interference from the saboteurs in the opposition.

One of the key reasons the markets are wrong is that the champions of a soft Brexit are mainly in the opposition benches, and if their numbers drop so does opposition to a hard Brexit. The Tories calculate that UKIP is a busted flush and that many of their votes will come back to hard Brexit focused Tory candidates. They also know that with many working class traditional Labour constituencies in areas such as Sunderland, Liverpool and the North East of England having voted Leave, Labour can’t attract the anti EU vote without losing even more to the Tories.

So the new Tory candidates in England and Wales are campaigning on a platform of putting the EU in its place, cutting immigration and claiming that post-Brexit bilateral trade deals outwith EU control will boost the economy more than the single market membership would (it won’t).

The problem therefore is that an enlarged Tory majority makes it more likely that the UK will leave the customs union and limit its access to the single market – that outcome would bring the pound into “parity with the dollar territory”.

Interest rates are being held low by the Bank of England and that’s great for mortgage payers, but the fact that the UK is a massive net importer of goods means that with a weaker pound inflation has started to rise. Inflation has now had two months in a row at 2.3 per cent surpassing the Bank of England’s two per cent target and it may hit three per cent in the summertime, sparking increased interest rates which will temporarily strengthen the pound making any Brexit-led Sterling collapse later in the year more severe.

Wages continue to be depressed and personal debt is climbing to record levels, with credit card debt (the most problematic) close to 11 per cent growth. So any increase in interest rates will put a squeeze on household spending – which drives 75 per cent of the economy. Higher interest rates will also have an impact on the housing market slowing growth in values and in overpriced areas such as London and the south-east a crash later this year/early 2018 starts to look more likely. So the pound rallying could well be short lived, inflation will increase squeezing household spending, slowing the economy and increased interest rates will slow the housing market and risk a well overdue personal debt crisis.

All this will happen just as we get confirmation of the hard Brexit and probably World Trade Organisation (WTO) tariffs will apply.

To give some idea of how this will affect trade, a report out yesterday by UK Oil and Gas stated that the UK’s access to trade agreements with the rest of the world through our EU membership keeps the cost of trade (tariffs) on the £61 billion of oil and gas related products down to £600m and that reverting the WTO rules would be the worst case scenario; it would be likely that cost of trade would almost double to around £1.1bn per annum.

Despite the increasingly negative economic indicators showing a slowing down of the UK economy and the currency collapse the real economic impact of Brexit hasn’t happened yet.

However, across the board WTO tariff increases would start to prove that the UK economy is not robust enough to handle a hard Brexit without serious pain for ordinary people. If I were Theresa May I would also want a big majority now, and not to have to go to the polls again in 2020. Effectively she is asking both for a hard Brexit mandate and for enough time to recover from the worst of the self inflicted damage before seeking re-election.

About the author

Gordon MacIntyre-Kemp

Gordon MacIntyre-Kemp is the Founder and Chief Executive of Business for Scotland. Before becoming CEO of Business for Scotland Gordon ran a business strategy and social media, sales & marketing consultancy.

With a degree in business, marketing and economics, Gordon has worked as an economic development planning professional, and in marketing roles specialising in pricing modelling and promotional evaluation for global companies (including P&G).

Gordon benefits (not suffers) from dyslexia, and is a proponent of the emerging New Economics School. Gordon contributes articles to Business for Scotland, The National and Believe in Scotland.

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