We should welcome sterling’s post-election adjustment

As shock absorbers go, the pound’s 2 per cent downward reaction against the euro and dollar to the “shock” election outcome was comparatively muted – especially when compared to the approximately 7 per cent decline it “suffered” in the immediate aftermath of the “shock” vote to Leave the EU.

I chose to use inverted commas because in many ways there is as much, if not indeed more, to welcome a more competitive currency as there is to fear it.

The question is, of course, where can we expect sterling to be in say, two years once Brexit has finally become a reality?

Since exchange rates are relative prices, the answer requires as much an understanding of the economic and monetary fundamentals of the eurozone and United States as those of the United Kingdom, once it is outside the European Union.

The latter of course requires us to anticipate the precise nature of the UK’s relationship with what will soon become its erstwhile EU partners.

Let me make clear that, for all the talk of hard-bargaining, I expect a conciliatory separation, such that the UK continues to seamlessly engage commercially with the EU27. In the event matters went differently, say if there was a “tariff shock” to the flow of goods and services into and out of the UK from the EU27, then I would expect the pound to decline proportionately against the euro, and so in large part help shock absorb for this.

Returning to a Brexit which is devoid of hubris from either side, I still expect that in two years or so the pound will be actually lower against the euro to the 1.14 it finds itself today. I say this because I expect the European Central Bank to act monetarily more hawkishly than the Bank of England.

Despite recent reticence, I believe that before too long the ECB will be forced – by the powerful German lobby within it – to react to signs of reflation and recovery across the eurozone and to announce that quantitative easing will definitely not extend beyond this year, while also “guiding” that interest rates may need to rise soon into 2018.

For its part, the BoE is now set to keep monetary policy ultra-loose for longer, doing so in the face of the real or perceived economic uncertainty born of domestic politics, Brexit negotiations and the two combined.

In short, I anticipate something of a “taper-tantrum” in the euro, similar to what we saw with the dollar four years ago. This would involve the euro strengthening across multiple exchange rate dimensions, so not only relative to the pound but the dollar et al. This of course brings me to considering where the cable rate, currently below 1.30, might find itself in two or so years.

What I would say here is that, whatever economic uncertainty may have been unleashed by our recent General Election, matters in the US are – to my mind – no less fraught and potentially far more so. I would, for instance, not dismiss the real possibility that the President turns his bile towards the head of the Federal Open Market Committee, just as he has done to the ousted head of the FBI.

The “politicisation” of US monetary policy would hardly support the dollar and almost certainly act to undermine it. Indeed, one could point to Donald Trump’s claims while on the campaigning stump that the dollar was being kept uncompetitively high by self-interested foreign forces – from the Chinese to the Germans – to argue he would welcome a weakened dollar.

So to recap, from the vantage point of June 2019 I would not be surprised to see the pound actually weaker than it currently is today against the euro, but stronger relative to the dollar. As to how much in each case, more markedly higher against the dollar than lower versus the euro.

What this means for the UK economy is an inflation cushion in one dimension and in the other improved competitiveness – neither unwelcome to my mind.

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