Welcoming a Weaker Pound
Despite common assumption, a weaker pound could have positive effects on a stagnant UK economy battling a destructive pandemic and an imminent departure from the EU
Following the Brexit referendum, the pound quickly fell around 20% against the euro over the course of the next year. If the efficient market hypothesis stands, then the Brexit slump has sliced a significant value from the total wealth of the UK. Since the COVID-19 pandemic however, a promising Brexit deal and a successful vaccination programme has led to consistent rally against the Euro through December of 2020 and into the new year.
This positive outlook seems auspicious, but is a strong pound what the UK really wants? It may be ideal for holidaymakers looking to get the most bang for their buck on a long weekend in Venice, but its effects on the economy as a whole are both remarkedly similar, but vastly different at the same time.
Winners of a stronger pound
Besides from adventurous Brits looking to travel the world, there are certainly other beneficiaries of a rising domestic currency. The main consequence of a stronger pound is imports are made cheaper, as the UK can receive more foreign currency per pound. As a result, firms and corporations that rely on imports will have their costs of production reduced, leading to higher profit margins or more sales.
Historically, the UK current account has run in a deficit, meaning it imports more than it exports. At present a large proportion of UK imports were in pharmaceuticals due to the COVID-19 pandemic. This means that vaccines and PPE equipment can be bought at cheaper prices, reducing government borrowing that is required to attain these items. Clearly then, a current account deficit will welcome a stronger pound, as the majority of its trade will be cheaper and therefore have the greatest benefit to our current account.
Similarly, as UK firms’ costs of production depletes, they may be able to lower prices and capture a larger piece of the market share. As prices fall, inflation will be lowered. Hence, during periods of high inflation a strong pound can help to control price levels within an economy.
Other beneficiaries of a strong pound are those on fixed incomes: bondholders, annuity recipients, lottery winners etc. Not only will the foreign purchasing power of their money naturally rise, but lowering inflation means a smaller proportion of their wealth loses purchasing power.
Finally, a rising pound encourages immigration. Macroeconomic incentives that arise due to a strong domestic currency, such as low inflation and high interest rates, are desirable for foreigners. As a result, they may choose to move to the UK, earn money through wages and holding money in a bank account, and send these back as remittances to their country of origin. The remittances they send will be of greater value, as the exchange rate back into their own currency will be higher. Consequently, both the migrants and the UK are better off.
Winners of a weaker pound
Conversely to a strong pound, a weak pound makes imports more expensive, but exports cheaper. This is desirable for domestic firms looking to sell their goods abroad, as foreign companies will be able to buy more domestic goods. 16% of exports out of the UK go to the US, therefore a rising dollar may be beneficial to companies with American exposure. The manufacturing and engineering sector in the UK will also benefit greatly as car exports, which make up 7% of the total UK exports, will have a higher demand. A cheaper currency will drive commerce.
Around 70% of the FTSE 100 constituents’ revenues come from overseas. Consequently, a cheap pound will benefit them greatly when they exchange foreign profits back into pounds, with a larger return. Ceteris paribus, the FTSE moves in reverse to exchange rates due to this mechanism of exchange of foreign currencies into British pounds.
The UK tourism industry may also boom during periods of low exchange rates. Foreigners’ costs of visiting the UK will be less as they can exchange more dollars or euros per pound and can therefore visit the UK at a lower cost. Large and attractive UK cities will benefit, but also the bucolic seaside regions that the UK offers could see a rise in demand for holidays.
Finally, but definitely not least, foreign investment into the UK will see a rise when the pound is cheap. Houses and infrastructure are cheaper, increasing return on investment for these firms, and thus incentivising increased cash flows into the UK. The US accounted for almost a quarter of all inward FDI stock in 2019; a strong dollar could have been a driver behind this.
Which one’s best?
On the one hand, a strong pound is desirable for the UK economy. Its large reliance on imports would be benefitted by this, causing lower production costs and maintaining low levels of inflation. Furthermore, immigration is crucial in driving growth and innovation in a country, and the more we can encourage it the potential for rewards will rise correspondingly.
However, the UK has longed for rising prices and an increase in growth for years through a period of tough secular stagnation. Prolonged periods of low inflation and stunted growth has been a persistent macroeconomic issue for the government and the Bank of England to deal with. Therefore, a weak pound could contribute to attaining long forgotten high inflation. Further, interest rates could then be raised to levels unseen in the 21st century.
On analysis of the UK economy, which possesses a liberal economy and a robust financial services sector, it can be a very attractive hub for FDI, which would benefit from a weakening dollar. Therefore, with the help of America, investments in infrastructure can increase the long-term productivity of our nation and drive economic growth into the future.
In a future where the UK no longer is part of the European Union, a weak pound could definitely have great benefits too. It will allow the island to prosper as a lone trading nation, as exports will thrive, and domestic firms may see larger profits abroad. The manufacturing industry will prosper, supplying vehicles all over Europe, alongside its signature financial services sector. This will enable the UK to establish itself as an individual powerhouse and prove that it does not need to rely on the EU for growth and development.
Conclusively, an initial fall in the pound would catalyse subsequent rises in growth coming out of a coronavirus pandemic and a Brexit trade deal, while also boosting the stagnant FTSE index. It can kickstart a new era for the UK, where it serves as a global provider of financial services, along with a prolific manufacture of cars and vehicles across the EU and America. Further along the line, as the UK prospers, the pound could begin to rise, allowing us to invest generously overseas and drive profits from all over the world.
This cycle could prove vital to the future of an island with a huge potential.
If you enjoyed this article please👏 (up to 50 times) or if you have any feedback feel free to comment below! Click here for my previous blog.
Ted Jeffery
