Brexit, sterling and spending power

This article is part of
Guide to Brexit one year on

“The reality is that the elasticity of demand of domestic consumers for imports, and of foreign consumer of British exports is quite low. Historically, the quantity of imports or exports consumed has changed little in periods of sterling weakness,” he suggests. 

“The devaluation will help the UK’s net external investment position, with the UK having more foreign currency assets than liabilities. However, this will be of scant consolation to UK consumers while they try and digest this admittedly transitory bout of imported inflationary pressure armed only with stagnant wages and a regulator just starting to sound a little more cautious on the credit outlook.”

While consumers earned a slight reprieve in June as inflation dropped to 2.6 per cent, there are many who still think inflation has the potential to hit 3 per cent in 2017.

Wouter Sturkenboom, senior investment strategist at Russell Investments, is working on the assumption the UK economy will continue to slow down “as the pain from higher inflation and slower wage growth lowers the living standards of the UK consumer, hitherto the engine of economic growth”. 

He adds: “This will continue as inflation rises to 3 per cent in 2017 and could accelerate if unemployment creeps higher due to a slowdown in business investment and housing construction.”

With inflation having reared its head again, all eyes have been on the Bank of England as one way to curtail the rate of inflation could be to hike interest rates.

At the last Monetary Policy Committee (MPC) meeting in June, three members voted for a rate rise.

Complicated picture

But complicating the picture is the spectre of Brexit, as Ed Hutchings, UK sovereign portfolio manager at Aviva Investors, points out.

“[Mark] Carney has highlighted the transitory nature of inflation on numerous occasions. The sharp rise in inflation over the last year is mainly a result of the depreciation of sterling following the EU referendum and much of the impact has now fed through,” he explains.

“Nevertheless, in its latest inflation report, the Bank said the fall in sterling is likely to keep inflation above its 2 per cent target throughout the next three years, which arguably gives the MPC grounds for a more hawkish stance.”

Mr Hutchings warns: “However, given the uncertainty around the UK’s economic prospects, it is difficult to argue for a rise in interest rates. Such a move might precipitate weaker consumer spending at a time of great uncertainty. 

“There is no clear visibility as to what the UK’s exit deal from the European Union will look like two years hence.”