Sterling has reversed weeks of falls in just a few days, is this the markets saying: “we believe in the UK?” Are they saying: “We think the UK is set for a good run?” Forget about Brexit, the UK looks good?”
UK Inflation has been rising – hitting 2.9 per cent in July – but wages are not growing so fast, meaning real wages are falling. The UK economy was the joint slowest growing economy in the EU during the first half of this year, and this is largely down to the falls in the pound seen post Brexit vote. Just before the vote, there were around 1.48 dollars to the pound. Within a couple of months, just 1.22. Against the euro, there 1.30 euros to the pound before the vote, a day or so after, just 1.17 and 1.11 a few months later that that.
It takes time for falls in the pound to show in the inflation data, which is why there has been a time lag of over a year between referendum and inflation surging.
On the other hand, the cheaper pound, had a positive effect on the share price of UK listed companies, especially multinationals which post a big chunk of their revenue in overseas currency, lifting profits valued in sterling.
The good news about the fall in the pound is that it stopped and even went into mild reverse at the end of last year, leading economists to suggest that it would peak at around three per cent in 2017, and then fall back, eventually lifting real wages
Then in June 2017, we had the UK election, and sterling fell again – down to just 1.8 euros the pound as of a few weeks ago. Many feared another rise in inflation in 2018, as a result.
But the last few days has seen sterling rise rapidly, to 1.35 dollars to the pound and close to 1.14 euros to the pound.
All of a sudden, the markets are putting money into the UK. Is this a vote of confidence? Does it mean that they have seen though the rhetoric of the Brexit negotiations and can see light at the end of the tunnel?
Actually, the pound rose because the Bank of England’s rate setting committee said that UK rates will be rising soon. And they made that announcement because they still have niggling fears about inflation.
The pound isn’t up because the markets are voting for UK plc, it is up because of fears over inflation, at a time when in the euro area, inflation is about as threatening as a hamster in a good mood.
What are the implications? Frankly, if UK interest rates rise from an all-time low to a level that was, until recently the all-time low, it may all be a fuss about very little
But the UK has seen a sharp rise in credit and unsecured borrowing, and house prices are being supported by low interest rates. According to property web site Rightmove, asking prices of property in London are now falling quite sharply.
If UK rates return to the 0.5 per cent, the level they occupied for most of the last ten years, then the changes really are not that much of a big deal. But if the Bank of England decides it need to increase rates much higher, up to say 1½ per cent, then UK house prices, mortgages and a lot of debt will start looking very expensive.