Sterling's Demise

If you have been paying attention to the currency markets today - and to be honest this is the the only time of year that many people actually do - you may have noticed the pound sliding towards a 35 year low versus the dollar. It's currently fallen to $1.22 and is clinging on to the cliff face.

What could possibly be causing this precipitous decline when our new PM is telling us how rosy things look in his imaginary wonderland? Hmmm, let me think about that for a second ...

It's really pretty simple. Currency fluctuations are driven by supply and demand for a currency relative to other currencies - create more demand for your currency and it will appreciate because more people want to buy it eg. so they can then use it to buy goods in sterling or to invest in assets denominated in sterling. Conversely, reduce the demand and it will decline. It's not rocket science.

So why is demand for sterling reducing now - surely the currency markets are just as excited about the appointment of Boris Johnson as PM as the Brexit Party entryists into the Tory Party are? Er, no - they are not. Sterling is extending the collapse it started after the EU referendum in 2016 because of several factors all a result of the new PMs current gamble.

First, the markets anticipate there will be reduced demand for British goods and services. As a consequence of having no trade-deal with our largest and closest trading partner - the EU - Britain will overnight become significantly less competitive than it is now. Reduced demand for British goods means reduced demand for the currency with which to buy those goods - and so it falls in value.

Second, they expect interest rates to be cut as an emergency measure to dig us out of the slump we will fall into after a no-deal exit. We are already entering the Brexit recession now - a no deal Brexit will make that slump an abyss. So with the prospect of the Governor of the BOE cutting interest rates in November and sterling assets making reduced returns going forward, markets are looking elsewhere for better returns and so are buying other more attractive currencies. Demand is reduced, the currency falls.

Third, the government is promising all manner of unfunded spending pledges to prop up a failing economy after a no deal Brexit. Not spending to improve productivity or spending on projects which will make a positive return on investment but deficit-financed spending on subsidies to prevent whole industries going under - farming for instance. Increased borrowing ultimately leads to inflation which erodes the relative purchasing power of sterling, which reduces demand for it and so it falls in value.

Fourth, Britain is now viewed as a significant political risk - markets will not invest in countries with unstable, irrational politics and unpredictable economics. Lower investment leads to lower demand for the currency and therefore lower relative value.

For all these reasons and more the markets are bailing out of sterling. This is not Project Fear, this is not political partisanship, this is the markets taking a cold-eyed, unsentimental look at where this country is heading and making a judgement call. The current slide in the value of sterling is an early vote of no-confidence in this government. Johnson's most significant 'accomplishment' in office may be to achieve parity with the dollar which would make the benefits of his much-trumpeted 'humungous' trade deal with United States truly risible.