It has been a torrid couple of weeks for the pound. A growing expectation that the UK is heading out, not just of the EU, but of its single market, has led to a further lurch down in the value of the pound. Against a basket of currencies sterling came close to its lowest ever level last week. Last Friday it was trading at $1.22, down 16% from pre-referendum levels.
The renewed slide in the pound started earlier this month with the Prime Minister's speech to the Conservative Party conference. Mrs May seemed to rule out accepting continued free movement of EU nationals in return for access to the EU's customs and duty free Single Market saying, "We will do what independent, sovereign countries do. We will decide for ourselves how we control immigration. And we will be free to pass our own laws."
For me the surprise was not what Mrs May said but the foreign exchange market's reaction to it. The Leave vote has handed the government the task of securing an exit from the EU that is saleable to the UK electorate. Leaving the EU and staying inside the single market, the course that is minimally disruptive, would leave the UK subject to free movement of EU nationals and EU regulations over which it has no control. For much of business sector this is the next best thing to staying in the EU.
But would it work politically?
Prime Minister David Cameron didn't think so. In a speech a year ago he ruled out the so-called Norway option, pointing out that outside the EU Norway pays twice as much per head into the UK as the EU, accepts free movement of EU nationals and all regulation but, "with no seat at the table, no ability to negotiate".
Markets have, belatedly, locked onto the political forces at work and the likelihood that the UK will leave the single market. A weaker pound is the mechanism through which market view on the effects of Brexit is expressed.
That view is downbeat. A weaker pound will certainly fuel inflation and squeeze consumer spending and growth in the medium term. The UK could lose chunks of its high value finance sector to Europe. Some argue that the UK's manufacturing sector is too small and orientated to selling in Europe to fill the gap by raising exports. Outside the Single Market the UK will, many fear, trade less and become more insular. The pound is falling because foreign exchange markets believe that the UK will become a slower growth economy. This conforms to the widespread, though not universal, view among economic forecasters before the referendum, that leaving the EU would reduce UK growth in the long term.
The US economist Nouriel Roubini, nicknamed Dr Doom for forecasting the financial crisis, summed up what he saw as the UK's predicament thus: "the risk is not that the U.K. has a recession of two-three quarters; the risk is that the U.K. will stagnate at 1 percent growth for the next five years." In a similar vein the Economist newspaper, a firm critic of Brexit, reiterated its view in an article last week entitled, "Brexit will make Britain poorer and meaner".
There are other possibilities.
One is that the UK may extract itself from the single market on more favourable terms. Because of the scale of the UK market and the UK's outsize trade deficit with the EU, tariffs and barriers to trade would be damaging to companies in the EU as well as those in the UK. To pro-Brexit Ministers including David Davis and Liam Fox, the EU would be cutting off its nose to spite its face by erecting barriers to trade. There is talk of the UK trying to negotiate partial or transitional access to the single market, perhaps in return for the UK making further budget contributions. Optimists also argue that, with the UK negotiating its own trade deals, it will be better placed to strike deals with non-European countries and increase UK exports to the fastest growing regions of the world.
A weaker pound could be part of the adjustment mechanism for the UK outside the EU. This case has been made by two US-based economists, Paul Krugman, the Nobel laurate economist and Ashoka Mody, a professor at Stanford University, in recent days. Professor Mody said last week that the UK's attractiveness to foreign investors before the referendum had led to huge capital inflows in search of UK assets and had pushed sterling some 20-25% above its equilibrium level. The UK has been suffering from same problem that the Netherlands faced in the 1970s when gas revenues sent its currency soaring, dampening manufactured exports and unbalancing the economy. To Professors Mody and Krugman, a weaker pound will help cure the UK of the "Dutch disease", rebalancing the economy towards exports and away from import-fuelled consumption.
Gregg Ip, a veteran US financial journalist on the Wall Street Journal, sees the UK on the verge of a profound adjustment: "Brexit is thus turning out to be a useful test case for de-globalisation. Raising barriers to the free flow of goods, services, capital and people need not entail recession or panic. It may even redress some of the grievances behind the anti-globalisation backlash. If Britain exports fewer financial services and more manufactured goods and tourism, the income gap between London and the rest of the country should narrow".
On one issue there is widespread agreement. Whatever the consequences of a weaker pound, the UK does not have the firepower in terms of foreign currency reserves to prop up sterling. The government has little choice but to make a virtue of necessity and play up the benefits of a weaker pound.
Of course the Brexit settlement will not be the sole determinant of the UK's economic performance over the next 10 years – any more than EU membership has been in the last 10 years.
Trends in global growth, commodity prices and interest rates will play a major role. So, too, will the response of UK institutions and corporates. The path to leaving the EU will be messy and complex, but the starting point is an economy which is in decent shape, rated in international league tables as one of the world's most competitive.
Brexit will itself alter domestic policy. The risks created by leaving the EU have prompted an interest rate reduction, a further round of Quantitative Easing, a sharply lower pound and caused the government to scrap its target for eliminating the public sector deficit. In short Brexit spells looser monetary and fiscal policy.
Membership of the EU has been a central aspect of UK policy for 40 years. Outside the EU the UK will need to create new structures and a new framework for the economy. The weakness of sterling suggests that the foreign exchange markets fear this new settlement will be bad for business and for growth.
In her speech to the Conservative Party conference, Mrs May said that the Brexit vote signalled a sense of unfairness and that, "the world works well for a privileged few, but not for them...it was a vote not just to change Britain's relationship with the European Union, but to call for a change in the way our country works – and the people for whom it works – forever".
The foreign exchange market seems to have interpreted this as a sign that the UK may be heading towards more business-sceptical policies. Brexit, coupled with the erosion of the UK's pro-market economic consensus, would represent an unsettling combination for markets.
The government's intention may well be to take the UK out of the single market, but it hardly seems likely to ditch economic liberalism. At times of uncertainty policymakers need to offer vision. Political judgements will necessarily play a major role in the design of the Brexit settlement, especially on the issue of free movement. But policies that reinforce the UK's pro-business culture would offer powerful reassurance about the direction of travel outside the EU.
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