Britain faces Project Reality

FRIDAY was the day when international markets absorbed the shock of the British vote to leave the EU; a vote that few investors had anticipated. But today, market focus shifted back to the places where the vote is likely to have the biggest impact; on Britain and its European neighbours.

The biggest impact was on the pound, which continued Friday’s big decline, especially against the US dollar, falling by another five cents to lkess than $1.32, its lowest level since the mid-1980s. The weaker pound reflects the expectation that the UK will be a less attractive destination for foreign investment; with a 7% current account deficit in the last quarter of 2015, Britain needs to attract foreign capital. A weak pound helps a bit by making UK assets cheaper and thus more attractive.

But it may not help a lot. First, there is the J-curve effect; imports become instantly more expensive and this widens the deficit. It takes time to crank up exports. And Britain’s manufacturing sector is quite small; the last big decline in the pound in 2008-09 did not eliminate the current account deficit. What a lower pound does mean is higher…Continue reading

This post was originally published in the Economist.

Britain faces Project Reality

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