The markets are expecting a hard Brexit

The continued downward adjustment of £-Sterling to a new historical all-time low has triggered plenty of comment. The public got their first glimpse of the upward price pressures the currency weakness introduces through Tesco’s ‘Marmite’ spat with Unilever, who tried to push through price hikes of 10% on the back of it. Together with a rising probability of Russia and Saudi Arabia agreeing oil price supporting production cuts,  makes the end of deflationary pressures for the UK a near certainty for 2017.

If the global economy continues to expand at the recent growth rates, then this does not have to be bad news for the shorter term economic outlook for the UK.

The continued decline of £-Sterling against the US$ – now over 20% – tells us that large parts of the international capital markets are increasingly seeing a ‘hard Brexit’ with all its pains for the UK’s long term trade position as an inevitability. I wonder whether they are once again failing to read political statements adequately for what they are: Propaganda to woo the electorate. The fact is that the UK Tory government has a very slim parliamentary majority which it may well want to extend by calling an early election next year.  France and Germany are both facing national leadership elections and are therefore very unlikely to concede to any British Brexit demands which their domestic opposition may be able to portray as weakness. Business may want to follow a softer agenda, but they are not the electorate, which as the Brexit vote showed sometimes has very different priorities.

I would therefore not be surprised if this leads to 12 months of unconstructive political posturing while we continue to operate under the status quo of the existing economic framework.

This means that there is little reason to expect £-Sterling to strengthen significantly from here and indeed depending on how ‘determined’ politicians want to appear to be pushing through national interests, there may be additional downside to the value of the UK’s currency.

While some of the potential long term effects of the currency weakness may appear quite worrying, there may not be too much downside in the short term. As long as the UK’s consumers retain their relatively upbeat outlook and businesses follow their stoic British attitude of ‘just get on with it’, then the economic direction may still be more along the upward trajectory recorded over August and September. Otherwise there is an as of yet small possibility of a rapid descent into a stagflation slowdown, where the devaluation turns and starts to drive up interest rates and forces a reduction of demand and consumption for the sake of defending the value of the Pound.

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