The pound has fallen sharply against the euro, expect the impact to bite next year.
A month ago, the head of the European Central Bank (ECB), Mario Draghi, appeared to drop a hint that the period of quantitative easing (QE) in the euro area was due to come to an end. At about the same time, the governor of the Bank of England Mark Carney, suggested he was coming around to the view that UK interest rates need to rise. For a few moments, the markets were at sixes and sevens, not sure how to react, and then a spokesperson for the ECB piped up and said Mr Draghi’s comments had been misunderstood.
Well, it turns out they weren’t misunderstood by that much, yesterday he gave a much bigger hint. He didn’t say it exactly, central bankers don’t, they use subtle language, saying things like, “all things considered, our view has not materially changed except in ways that it has materially changed”. Alan Greenspan, the former chair at the US Federal Reserve once said: “If you think I am making myself clear, then you have probably misunderstood me.”
Yesterday, at the ECB press conference Mario Draghi was asked if the bank was set to begin reducing QE in September? He was non-committal, and the press, analysts and the markets read much into that.
It may not seem like that big a deal, after all, the FED and Bank of England ceased doing QE some time ago, but in the world of central baking, subtle changes are a big deal.
We are seeing something of a curiosity at the moment. Inflation is falling again. Both the Eurozone economy and the US are growing at a reasonably brisk pace, unemployment is exceptionally low in both the UK and US, yet inflation is as damp as a squib.
In the UK, it is slightly different – inflation has been rising of late, although it did fall back somewhat in June, most agree it is on course for exceeding three per cent this year.
The reason why the UK is different is because of sterling. Sterling fell after the Brexit vote, but then swiftly saw a mini recovery. UK inflation has been rising thanks to the delayed effect of last year’s falls in the pound.
But following the June election, the pound fell again, and now, with the ECB apparently close to pulling back on QE, it has fallen some more, but only against the euro.
Against the dollar, the pound did not change that much – there is a feeling that while the ECB may be close to a period of tightening monetary policy, the FED may be close to the end of its tightening cycle.
And that brings us back to the pound. At the time of writing, there are 1.1157 euros to the pound, that makes the pound the cheapest it has been against the euro since last October. To put this in context, before the Brexit vote, there were around 1.30 euros to the pound, sterling dropped steadily after the vote, finally reaching around 1.11 in October last year, before picking up, moving close to 1.20 by April of this year.
So, what we have seen in the last three months is a pretty steep fall in the pound, the inflationary effect is likely to occur in around 12 months time.
Here is another curiosity, in 2010, the pound fell sharply too, and those on the right wing of the Tory party warned that this was a disaster in the making, hence the rationale for austerity. But this time around, many of those same politicians have welcomed the fall in the pound, saying it is what the UK needs to see an export led boom – strange indeed!
What we can say is that the recent falls in sterling mean that UK inflation will be higher than in the US and euro area for some time to come, and that means real wages (increases in wages minus inflation) are likely to carry on falling for at least a year, maybe a good deal longer.