When political leaders set out their ambitions for the British economy, they typically focus on measures such as inflation and growth. Rishi Sunak wants to halve inflation this year. Keir Starmer’s mission is to achieve the highest sustained GDP growth in the G7. Neither mentions the value of the pound even though it is a crucial yardstick, determined not by warm words but by cold calculations in the foreign exchange markets.
This is surprising, since a collapsing currency last September was one of the main reasons why Liz Truss’s premiership imploded. At its nadir the pound had fallen to an all-time low of $1.035, as traders took fright at a government defying budgetary constraints.
That autumn sterling crisis echoed an earlier one when, in September 1976, Labour chancellor Denis Healey had to abandon his plan to attend the IMF’s annual meeting held that year in Manila and turn back from Heathrow. A stricken pound forced his hand, and the following day the government applied for an IMF loan. “It was the lowest point of my period at the Treasury,” he wrote in his memoirs. In 2022 Kwasi Kwarteng managed to get to the meeting, in Washington DC, but was summoned back to be dismissed as chancellor. That desperate move by Truss, who replaced him with Jeremy Hunt, wasn’t enough to save her job as prime minister.
Since sinking so low last September, the pound has staged a recovery, bringing some relief to holidaymakers travelling abroad this summer. In the middle of July sterling broke through $1.30, though it then edged down just below that, to $1.28 last Friday. The pound has appreciated less against the euro, trading at €1.16 at the end of last week.
But short-term currency moves can flatter to deceive as well as deliver bleak lessons. The pound had tumbled so far last autumn that there was plenty of ground to make up once Sunak and Hunt restored a degree of confidence in the government. Furthermore, the dollar, buoyed for most of 2022 by the Federal Reserve’s aggressive increases in interest rates, has since been weakening as markets anticipate an end to the American central bank’s tightening. At the same time, markets have factored in higher rates for longer in Britain because inflation has fallen less than in the US and the eurozone and appears more deeply embedded in wages and services.
In recent years the trend for sterling has been one of relentless decline. Go back in time to the day of the Brexit vote. When the markets closed on 23rd June 2016, the pound was worth $1.48 and €1.30. The following day, as the result became clear, sterling slumped by 8 per cent against the dollar, its biggest 24-hour fall since the floating exchange rate era began in the early 1970s (previously the value of the pound against the dollar had been fixed). Against the euro, the pound fell by 6 per cent.
In the past seven years the pound has never regained its pre-referendum worth. Whatever virtues Brexiters might have seen in leaving the EU, the markets’ instant verdict on the vote was that it would harm the British economy—a judgement since amply validated.
The trend for sterling has been one of relentless decline
A more distant but salutary historical comparison is the value of the pound when the euro came into being at the start of 1999. Sterling was then trading at $1.66 and €1.41. Against both currencies, the pound is now worth around a fifth less. Those rates were set by the markets, but in 2003 a report for the Treasury estimated that a sustainable rate for joining the euro was €1.37, while an acceptable rate against the dollar was $1.59—both much higher than sterling’s current values.
The fall in the pound against the euro should be particularly galling for Brexiters, given that one motivation for leaving the EU was a misplaced fear of being dragged into the monetary union. The single currency was a leap of faith and has had plenty of tricky problems to overcome, notably during its existential crisis of the early 2010s. And yet almost 25 years after its launch the euro, derided by some City traders as a “toilet currency” in its early days, has outperformed the pound.
Taking a still more long-term view, the decline of sterling encompasses not just the floating exchange rate era but the earlier fixed (but adjustable) exchange rate system set up after the Second World War. The Labour government led by Clement Attlee presided over a massive devaluation of 30 per cent against the dollar in September 1949, from just over $4 to $2.80. Two decades later, in November 1967, Harold Wilson’s government announced a further devaluation, from $2.80 to $2.40—a 14 per cent reduction. Wilson, who since winning power in 1964 had been dead set against such a move, was mocked when he appeared to claim that “the pound in the pocket” would not be affected.
Both devaluations were admissions that the British economy was no longer strong enough to warrant the value of the pound. Britain emerged after the war heavily indebted. The rate of $4.03 set in 1945 did not reflect the country’s diminished financial and economic standing. The devaluation in 1967 came after successive governments tried to drive up growth only to stumble as the current account of the balance of payments—measuring trade and income flows between the UK and other nations—lurched into deficit, forcing the Treasury to put on the brakes. The underlying problem was a country losing competitiveness as inflation in Britain outstripped that of the US and West Germany.
Britain’s short-lived and unhappy experience inside the European exchange rate mechanism, joining in 1990 and being forced out in 1992 (on “Black Wednesday” in September that year), was a reminder of those previous humbling devaluations. The lesson at the Treasury after that further humiliating episode was that the pound was best left to its own devices. Monetary policy should focus on controlling inflation, a job written into the heart of the newly independent Bank of England’s mandate in 1997.
But have the Treasury and the Bank become too indifferent to the fate of the pound? Sterling’s big fall following the referendum made British consumers poorer, by raising import prices. Researchers have calculated that by June 2018 it had pushed up consumer prices by 2.9 per cent. The pound’s depreciation in 2022, when it started the year at $1.35, exacerbated the surge in British inflation driven by higher energy prices.
As well as being better for consumers, a stronger currency puts firms under pressure to become more productive. If businesses come to expect the pound to slide down over the longer term, then that external discipline is weakened.
Ultimately, the pound will fare better only if the British economy’s fortunes improve. But a policy of benign neglect towards the exchange rate sends its own message: that the pound will take the strain when things get tough. Sterling has become a soft currency.