The pound has fallen again. Is this a disaster or are there positives too?
In different times they would call it a sterling crisis, but the markets seem to be saying no crisis here, thank you.
The pound is down again. Or is that yet again? It’s exchange rate is approaching 1.16 euros to the pound, while it is hovering around 1.30 dollars.
At different times there might have been a panic. The UK used to be beset, a sterling crisis every few years. But this time the markets seem sanguine.
Indeed, maybe more than sanguine.
No bond sales today, thank you
The yield on UK treasury bonds keeps falling to new lows – as I write these words the yield on UK ten-year government bonds is a mere 0.52%. When rates are that low, it is tempting to ask: Is debt really debt when it carries negative interest rates?
The markets seem to be saying that they like the cheap UK. They like the fact that the falls in the pound have made the UK’s assets appear cheaper to foreign buyers.
In fact, the appetite for government bonds is so high, that the Bank of England is struggling to buy bonds under its quantitative easing programme. When Mr Carney went out with a wallet full of cash, to buy up some bonds from pension and insurance companies recently, they said: “No thank you.” The Bank of England wanted to buy £1.17 billion worth, and offered to pay well over the market price.
It is possible to over-egg this one. The Bank did manage to buy £1.12 billion worth of bonds; it is just that it is very unusual for the Bank to be unable to buy the full amount it had targeted. The time for its next shopping spree is Monday 15 August, it will be interesting to see how it gets on.
Even so, as has been suggested here before, the Bank of England is struggling to have the impact that it is hoping for,
The process of the Bank of England buying longer term bonds, which is what it did so unsuccessfully this week, is what is meant when people say quantitative easing. So it’s all very well the Bank of England recently announcing £70 billion odd worth of quantitative easing, or QE, but if the pension funds and insurance companies don’t want to sell, it does rather lose its effectiveness.
Trade goes deeper into the red
Recently, the latest data on UK trade was released. It was bad. June saw a total deficit of £5.1 billion, with trade in goods seeing a £12.4 billion deficit, and trade in services seeing a £7.3 billion surplus. In Q2, the deficit was the highest since 2013. Bear in mind that the UK’s current account deficit – that’s the goods and services deficit plus net income from abroad, and a few other smaller items such as remittances from immigrants in the UK homewards and foreign aid, hit an all-time high last year.
The UK needs a cheaper pound to stimulate exports and reduce demand for overseas goods and services. But it takes time for a fall in the pound to have an impact – around two years in fact.
So that means that until the fall in the pound helps lift exports, the UK is reliant on internal demand.
It feels a bit messy. Some may say it is a recipe for a sterling crisis.
But a fall in the pound only normally becomes a crisis when the markets decide to stop putting their money into the UK. If money flows start heading away from the UK, then the government may have a problem borrowing the money it needs, or at least may have to agree to high-interest rates on its borrowings in order to entice investors. Things then get nasty. Back in 1976, when this happened, the UK had to ask the IMF for help.
But the Bank of England’s failure to buy the full number of bonds it had targeted this week shows that there is no problem this time around. The UK government can borrow money so cheaply that it feels as if the markets are practically begging it to borrow off them. In fact, for a while yesterday, the yield on some UK bonds went negative.
The perfect calm
In some way it feels like perfection. We are getting the benefits of a fall in sterling, namely a terms of trade boost, without the woe that often accompanies such a development, namely a rising cost of debt.
But it actually isn’t all good. The cheaper pound will push upwards on inflation. At some point towards the end of next year, UK inflation may temporarily go over 2%, or even over 3%. That won’t be a disaster, but it may mean that the growth in real wages may go negative, which won’t help consumer spending.
We all know what must happen next. The UK has got to start exporting more, but Brexit, and loss of trade deals with the EU, may make this harder.
The key is services. They are vital for the UK’s trade account, but it is often much harder to agree trade deals involving services than goods.
And that’s where the big challenge lies.