One notable short term impact of Brexit (Yes I know it hasn’t happened yet) is the plummeting of the pound. In this post I will talk about the basics of currency fluctuations and how it will effect people in the economy.
The pound has fallen by 18% against the dollar, the greatest plunge for 30 years and is having an impact on the economy.
Why is the pound falling?
Well this is because there isn’t much faith in the British economy from the markets. Brexit has lead to uncertainty, therefore with a recession on the line, people don’t want to invest. This is because a recession leads to lower interest rates, meaning that investors will get less reward from investing with British currency into British banks. The main reason for the pound falling and lack of confidence is Brexit
Bad football and economic puns aside, the idea of currency rates being self correcting is that a fall in the currency makes exports cheaper and imports more expensive.
So How will the fall in sterling affect consumers?
British consumers tend to import most of their goods. A fall of a currency leads to an increase in the prices of imports as it costs more pounds to buy euros to import goods with. This means an increase in the price of goods from outside the UK. This has been shown by Unilever asking for a 10% price increase in their products. Tea isn’t grown in the UK, so PG tips will require a higher price as a result of rising costs. This means that people will be able to buy less with their money and have less purchasing power.
But doesn’t this help domestic producers in this country?
Yes it could help people in this country as it makes their goods more competitive against imports. However it may promote inefficiency and branded goods like “Marmite” and “PG Tips” are generally price inelastic, in that a price increase won’t change the quantity sold by much, meaning that the price increase will do little to help domestic producers.
What about people sending goods abroad?
This should theoretically help British sellers abroad. As I mentioned above, a cheaper pound will reduce the price of British exports. This could make them more competitive.
However, both domestic and export producers may not feel the full benefits as they are likely to import raw materials from abroad (made more expensive by the falling pound), and this will mean a rising cost as well . The insecurity of the economy could also mean that international firms may be unwilling to do a long term deal with the British companies.
A further point is that the weakening of the pound (which is likely to be temporary) will do very little to offset the tariffs that will be enforced on half of our exports, should we leave the single market. This means that despite the gains from a fall in sterling, our goods will still be pretty uncompetitive anyway compared to pre-referendum.
And what about our trade balance?
This is one area where we are likely to improve assuming that we don’t lose competitive gains from the tariffs in the point above.
Assuming that we don’t, our trade balance should improve in the long run as we export more and import less. However, in the short run it will get worse as companies can’t change suppliers due to the fact that it takes time and most have long term agreements.
The elasticity of price of imports/exports would also affect the balance. If our imports are inelastic (demand is irresponsive to price), it would mean that we would be spending more than before on imports making our trade balance worse.
Well I hope you feel a little bit more informed about what the fall of the pound will mean for the United Kingdom. The fall in the pound is good news for some and bad for others. It’s either a love or hate thing, ironically like marmite which has been hitting the headlines. Any questions find me on social media @SwiftEconomist or leave them in the comments.