The big squeeze
Inflation tipped to soar past 3 per cent Holidaymakers get just €1 for every £1 Trade gap may grow to 10 per cent of GDP
BRITONS face a cut in their real wages as the collapsing value of the pound stokes inflation, economists are warning this weekend.
Sterling, already languishing after the Brexit vote, took a fresh battering late last week, and economists warn that the falling pound could lead to inflation soaring to 3 per cent or higher next year. With pay rises averaging just 2.3 per cent a year, the higher prices would mean a cut in earnings in real terms.
Paul Hollingsworth at research firm Capital Economics said: ‘The Bank of England’s rule of thumb is that a 10 per cent fall in sterling boosts inflation by 3 percentage points in two to three years.’
Sterling collapsed against the dollar and euro last week amid a hardening of the rhetoric on Britain’s exit from the European Union.
A pound was worth $1.24 on Friday night, down from $1.29 before the start of the Conservative Party Conference last weekend. And it fell to just €1.115 on Friday, meaning many travellers buying euros at the airport this weekend found they were getting parity – €1 for every pound – after commission and other fees.
The pound’s sharp fall on Asian markets late on Thursday night was blamed variously on human error and automated trading systems overreacting to Brexit headlines.
A series of speeches from Ministers pledging a ‘hard’ Brexit was followed by French president Francois Hollande saying Britain must ‘pay the price’ for its decision.
The ‘flash crash’ in early morning Asian trading on Friday saw the pound fall as low as $1.18 at one point. Hopes that the slump would be reversed in European trading on Friday were in vain.
A squeeze on wages will turn up the heat on the British economy, which has so far weathered the blow of the Brexit vote well amid buoyant consumer spending. A fall in the pound increases the cost of imported goods, which either reduces corporate profits or raises prices.
On a trade-weighted basis (a measure of the value of the pound, taking into account trade with other currencies) sterling has fallen 14 per cent since the Brexit vote on June 23.
Hollingsworth expects inflation to near 3 per cent next year, but others say it will go higher still. Samuel Tombs at consultancy Pantheon Economics said: ‘The sort of depreciation we’ve seen suggests a rate of 3.2 or 3.3 per cent in a year. Meanwhile earnings growth is stuck and I don’t expect it to go up, which means a new squeeze on real incomes.’
Some market experts suggest the pound could eventually drop to an all-time historic low of $1.05. Grant Lewis, head of research at broker Daiwa Capital Markets, said: ‘For foreign investors, the UK now looks a much riskier place to put money, putting further significant downward pressure on the currency.’ Any damage to financial services caused by a hard Brexit could see Britain’s current account deficit – the gap between exports and imports – widen to 10 per cent of gross domestic product, according to Lewis. It currently stands at about £29billion a year or 6 per cent.
HSBC meanwhile was predicting the pound would fall to $1.10, while analysts at Deutsche Bank said last week that they did not think the possibility of a hard Brexit was being reflected in the value of sterling, which would be lower if it were.
Oliver Harvey, macro strategist at Deutsche Bank, said: ‘Our takeaway from the conference was that Theresa May believes the threat of rebellion from hard-line Eurosceptic MPs is significantly greater than that from the centre of the party or a divided opposition – the corollary being a much tougher negotiating stance. The risk is that this does not play well with EU partners, particularly given French and German elections next year.’
The Bank of England said on Friday it would investigate the collapse in sterling. It has also asked the Bank for International Settlements – dubbed the central bankers’ bank – to look into it.
The risks posed by computerised trading systems were highlighted last year in the book Flash Boys by financial journalist Michael Lewis. Such algorithmic trades – or simply ‘algos’ – monitor economic data, market patterns and even news reports posted online, and set off automatic sell or buy commands upon certain triggers.
Bank of England deputy governor Jon Cunliffe is likely to be quizzed on the issue when he tells MPs on Wednesday what effect Brexit is having on the financial services sector and on financial stability.
The fall in sterling comes despite upbeat economic data since the referendum. The National Institute for Economic and Social Research said on Friday it expected third-quarter growth to come in at 0.4 per cent, rather than the mild recession predicted by the Treasury.
But some business leaders warn the pain is yet to come. One FTSE 100 boss told The Mail on Sunday this weekend: ‘The UK economy is like a frog in a pan of water. The question is how hot will it get?’
The UK economy is like a frog in a pan of water. The question is how hot will it get?