UK Pound

It is getting pounded and it could get worse…

graphThe UK£ recently touched a low of $1.18/£, which is the lowest level for the Pound in over 30 years. Over the last 30 years, the Pound has crashed during its ejection from the ECU in 1992 and later during the financial crisis in 2009. On both these occasions, the Pound did not dip below the $1.40/£ mark. The question, therefore, is what has prompted the UK£ to touch a 30-year low?

Primarily, it’s about BREXIT…

 Ever since the BREXIT vote, the pound has been on a downswing. BREXIT will mean that the UK will lose its special trading status within the EU. This becomes more critical for UK as the EU remains its largest trading partner. In the absence of special status within the EU, the UK may not benefit from a weaker Pound as it would hardly compensate for the benefits that UK was getting as an EU member. The fear on the street is that post-BREXIT there will be a sharp fall in UK trade and will also depress its overall GDP growth by 4-5% over the next 3 years. That is big for an economy the size of UK!

How to bridge my deficit?

The big challenge for the UK will be how to bridge its current account deficit (CAD). Remember, UK has a CAD of 6.5% of GDP. India faced a currency crisis in 2013 when its CAD touched 4.5% of GDP. In the past, a high CAD was never an issue because London being the financial centre of Europe, it could easily find buyers for its bonds. But with BREXIT, all that could change. Companies with headquarters in London are already looking to relocate their main operations out of London. VTB Bank of Russia is already looking to move out of London to Frankfurt or Paris. If UK loses access to the EU markets, then nobody will exact prefer London as the default financial market gateway to Europe.

Cheap money to stay…

One of the biggest risks for the Pound is that cheap money economics may come back. It was originally expected that once growth comes back to UK, then it will adopt a policy of gradual tightening to bring back inflation. With BREXIT becoming a reality, that looks unlikely to happen. On the interest rates front, UK may be moving towards much lower interest rates like the EU region. It will also be forced to continue its liquidity infusion till the BREXIT crisis gets over. Loose monetary policy means a weaker pound. For now, it looks like the UK£ will continue to be under attack! ©

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