A Further Devaluation Of The British Pound Can Help Avoid Deflationary Shocks

by: Societe Financiers

Summary

Statistical data on the economic performance of the UK's economy indicates a necessity of an additional monetary or fiscal stimulus.

The PMI index in the Services sector shows a very slow increase in three years, which is a signal for action.

The referendum’s outcome can greatly weaken the British currency.

On April 14, The Bank of England made a unanimous decision to keep the monetary policy unchanged. Thus, the central bank left interest rates unchanged at 0.5%, where they stood in March 2009.

In March, consumer prices in the UK rose by 0.5%, after stagnating on the level of 0.3% in the previous two months. The growth in consumer prices shows the highest rate of inflation since December 2014. This above-average rise in inflation in March can be explained by the rising cost of air travel due to the Easter holidays. This year, Easter came in March, whereas in the past year it was in April. Thus, we should expect a slight decrease in the level of inflation next month. Overall, inflation in the UK is a significant achievement for the monetary authorities.

(Source: tradingeconomics)

It is noteworthy that the weak currency has a positive effect on the British economy, especially on the British exports, which have grown since 2015 in tandem with inflation.

(Source: tradingeconomics.com)

At the same time, the PMI index in the Services sector reached a level of 53.7 in March from the February value of 52.7. However, this is the second lowest rate of growth in the last six months and the lowest in the last three years.

(Source: tradingeconomics)

The UK economic data generally show a slowdown in economic growth based on the PMI data in the Services sector and the growth of GDP. This may prompt the monetary authorities to start looking for incentives for growth. The public debt is also a problem for the British Pound as its size does not give room to more aggressive monetary and fiscal policies. This limitation occurs because of the peculiarities of legal norms, as well as budgetary framework imposed by the EU membership. The UK has the largest budget deficit in the EU, but because of the prolonged quantitative easing, the deficit has gradually been declining.

(Source: tradingeconomics)

Conclusion

In my opinion, a further weakening of the British currency will take place in the second half of 2016. The implementation of fiscal consolidation will help stimulate the economy and prevent the cardinal slowing down of economic growth. The growth of deflationary fears in connection with the slowdown in the Asia-Pacific economies raises concerns about the spread of deflationary shocks. For example, in 1997, the economies of the "Asian tigers" overheated. As a result, in June 1997, Thailand announced the devaluation of its currency. This fragment of history is very similar to the drastic weakening of the monetary policy in Singapore in the present time.

The necessary inflation levels can be achieved, for example, by the central bank's asset purchasing program. The expansion of the public debt can also be an option, but it remains a more difficult scenario to execute due to the reasons outlined above.

A fundamental reason for the weakening of the national currency in the future can be the outcome of the referendum on the UK's membership in the EU, since the full sovereignty of the United Kingdom will allow a significant increase in the inflow of foreign investment and help accelerate the pace of expansion of the Services sector, which currently accounts for 75% of the country's GDP.

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