British Pound Sterling Falls 5% in October
Over the last month, the British pound sterling has continued its downward trend, falling more than five percent against the U.S. dollar despite better-than-expected economic data.
The currency has fallen ever since Britain voted to leave the European Union (EU), suggesting that investors have looked poorly on the decision to abandon close ties with the EU. (Source: “U.K. Economy Can’t Shrug Off Brexit Forever,” The Wall Street Journal, October 27, 2016.)
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Many companies have threatened to move their businesses out of Britain in response to Brexit. On top of those potential roadblocks, the political process of enacting Brexit has not yet been triggered.
Article 50 of the Treaty of Lisbon is the biggest question mark in the U.K. right now, leaving a cloud of uncertainty hanging over the island’s business decisions. Politics is now steering the country’s economic fate, and the market finds that kind of chaos unnerving.
That being said, third-quarter GDP numbers were better than analysts had forecast. Britain managed to eke out 0.5% more output than in the previous quarter, despite contractions in agriculture, production, and construction. Almost all of the gains came from the service side of the economy.
Some pro-Brexit observers suggest that the positive GDP numbers show that Brexit fears were overblown. This is not necessarily true. The pro-Brexit commentators should consider that GDP data is a lagging indicator of real economic conditions, meaning it looks backwards.
Anti-Brexit analysts say that investors should be paying closer attention to metrics that face forward. Certainly, that is what the Bank of England (BoE) will be paying attention to, which is why it launched an aggressive stimulus program right after the Brexit referendum.
The BoE started cutting rates and buying bonds to prepare for the fallout from Brexit, something it knew wouldn’t be visible in the numbers for months down the road.
It is an unavoidable truth that the full extent of the damage will not be known until Article 50 has been triggered, so the Bank of England has a strong case. Perhaps the new GDP data weakened its case, but it is unlikely that the BoE will scale back support for markets at this delicate stage.
The Bank of England is likely to maintain an accommodating monetary policy stance heading into 2017.
