Sterling occupies temporary ‘sweet spot’, says Bank of England deputy

BoE

Sterling is set to occupy a “sweet spot” for businesses until the UK leaves the European Union, the Bank of England’s deputy governor has argued in a speech at Imperial College today.

Ben Broadbent, who has specific responsibility within the Bank for monetary policy, says the currency is in the unusual situation of reacting to a predicted negative event at least two years before that event comes to pass.

The earliest that the UK could leave the European Union, based on Theresa May sticking to her pledge to trigger Article 50 next Wednesday, is 29 March 2019.

In the meantime, UK exporting businesses enjoy more than two years of a significantly lower pound without suffering from restrictions on trading with the EU anticipated from Brexit negotiations once the UK leaves the single market and possibly the customs union.

“We’ve had the reaction in asset prices well ahead of the event,” Ben Broadbent explains.

“The result – higher prices and profits but unchanged rules and costs – represents something of a sweet spot for exporters and businesses that compete with imports.”

But this sweet spot is only temporary. If foreign exchange markets have correctly forecast the impact of Brexit, the UK will suffer restrictions to trade that would offset the 20 per cent drop in sterling.

Alternatively, if foreign exchange markets have been too pessimistic sterling will shoot up.

Broadbent argues this creates uncertainty that will discourage long-term investment that would typically result from currency depreciation stimulating export demand.

Despite a lack of data since the summer, it’s likely that profitability has improved significantly in the tradable sector of the economy, Broadbent argues. Non-financial corporate profits in aggregate rose 10 per cent in the year to Q3.

“If the currency market is right the UK’s future trading relationships will be less favourable; if it’s too pessimistic sterling is likely to rebound. Either way, future returns in the tradable sector may not be as healthy as they are right now.”

This is why economists still predict UK GDP growth to slow to 1.2 per cent in 2017 despite the positives that are normally associated with a depreciated currency.

Broadbent rejects use of the adjective “post-Brexit” and says until the UK’s official exit “pre-Brexit” should be used instead.

He adds that the MPC has no particular expectation about the forthcoming Brexit negotiations.