Behind the “Fall” of GBP
On September 26 this year, the exchange rate of GBP (Great Britain Pound) against the USD (US Dollar) fell to around 1 to 1.03 in early Asian trading, the lowest level since the British currency adopted decimal in 1971. In fact, if you take a cursory glance at the monthly movement of the GBP/USD exchange rate from 30 June 2021 to the present, you will find that GBP has experienced a somewhat shocking and continued depreciation during this period. What is the reason for this currency that was once the most widely used in the international settlement business to suffer a continuous and seemingly unstoppable recession crisis? What changes may happen to British society after the devaluation of GBP? Anyone who understands economics and has paid attention to the monetary conditions of the UK and the US over the past year can easily think of this: the increase in US dollar interest rates has widened the spread between GBP and USD, causing GBP to be sold and USD to be bought. This may be one of the main reasons for the devaluation of GBP according to some economists. However, LSE professor John Van Reenen denied this point of view in an interview. He believes that the main reason for the devaluation of GBP is that the British government is planning to use debt to significantly increase the budget deficit. He noted that there was no clear plan for how these debts would be repaid, leading to a sort of panic in financial markets. In addition, the poor external environment is also an important reason for the depreciation of GBP. After leaving the EU, the reality that the UK has to face is to adjust its trade cooperation with other EU member states, and meanwhile it has to explore other markets urgently, which has made itself under great pressure.
Due to the impact of the Russian-Ukrainian war on the European continent, the rising prices of commodities such as food and energy have led to rising costs, which has a greater negative effect on countries in Europe. This negative effect will have a concomitant effect on the deterioration of the basic indicators of the United Kingdom. Tan Yaling, an independent economist from China Foreign Exchange Investment Research Institute, supported these viewpoints.
A report from BOC Research Institute on October 14 pointed out that the depreciation of the pound may have the following effects: the British government bond market will be severely hit, and pension funds will fall into a “death spiral” under the liability-driven investment (LDI) strategy. Investors such as those who are from pension fund field are seeking to exit low liquidity assets such as real estate, private credit funds, etc., which will further accelerate the cross-market spread of financial risks. The sharp depreciation of GBP exchange rate will curb investment, increase the pressure on capital outflows, and cast a haze on the UK’s economic outlook. These events will absolutely exacerbate imported inflationary pressures, further increasing the burden on business operations and residents’ living. Obviously, if the UK fails to control inflation in a timely manner and introduce effective policies to curb the large exchange rate decreasing, more economic harm will occur. However, the devaluation of a country’s national currency is not without merit. The devaluation of GBP will bring a greater advantage to the UK’s export of goods in the future, which can be confirmed from the fact that the past GBP depreciation events have almost always brought greater economic growth to the UK. In addition, in terms of export trade, the devaluation of GBP will not cause a significant drop in demand because domestic importers have already signed agreements with foreign exporters before the currency depreciation. The price signed in the agreement is the price after currency exchange at that time, which made the pricing of some commodities escaped the exchange rate shock.
A recent report from Goldman Sachs showed that analysts’ annual growth forecast for the UK for 2023 has dropped from -0.4% to -1% after former Prime Minister Truss sacked Kwasi Kwarteng as chancellor and scrapped plans to raise corporate taxes. The report said this was resulted from weakening economic growth momentum in the UK, significantly tighter financial conditions and higher corporate taxes from April next year. Still, there are economists who are not affected by the pessimism that pervades the UK economy. Some of them noticed that when GBP fell to its lowest level on September 26 this year, many predicted that GBP might fall below parity against the dollar. However, fact came that GBP not only did not fall again for a period of time after that, but soon reached the level of 1.1496 USD per GBP on October 4, which reflected a certain resilience of British economy. The UK may be able to take full advantage of some (though not many) advantages of currency devaluation by shifting its economy from a domestic demand-led form to an export-led one.The future economic development of the UK will depend to a large extent on the UK government’s attitude towards the national economy and subsequent economic policies.
By Tao Cheng
