Thursday, 9 January 2020

Predictions For 2020 - Prediction 4 – The Pound Slowly Sinks and UK Interest Rates Rise

The Pound has moved in line with statements by the government over Brexit. Whenever the potential for a No Deal Brexit seems to have been reduced, or removed, the Pound rises, and vice versa. When Johnson reinforced his commitment to not extending the Transition Period, the Pound fell hard. For now, Johnson needs to try to hold his potentially fractious coalition together, and to sustain his honeymoon period with Brexit voters, by continuing to push this hard line. Whether he really believes that, by doing so, it will have any real impact on his EU interlocutors, in persuading them to give him a good deal – it won't – isn't clear. I'm sure neither he nor Cummings are that naïve. The Trumpian line that its necessary to threaten No Deal to get a good deal is fine red meat to throw out to the rubes, but no serious negotiator believes its a credible tactic, when its your opponent that holds all the cards, as is the case with the UK and the EU. 

So, for several months now, we are likely to see Johnson keep up the hard Brexit rhetoric, as he gets his ducks in a row, and prepares to settle accounts with the internal Tory Party opposition, which is his immediate threat. He's killed off the Faragists; their fifth column inside the Tory Party are still a problem, both at the parliamentary and constituency association level. Some of the rank and file are likely to go into semi-retirement on the basis of having got Brexit done. Others are dying off, but not fast enough to resolve Johnson's problem. One ironical saviour for Johnson might be the Liberals. The Liberals tanked in the election. They probably now see Brexit as a done deal. They are not fighters for principle outside waging parliamentary battles. The Liberals have also recently made a sharp right turn that actually goes back to their Orange Book prior to their coalition with the Tories in 2010. The Liberals and Tories fish in some of the same pools. There is every chance that Liberals, at local level, in many areas, could find their way into local Tory Associations. They could be flowing in as some of the UKIP/BP infiltrators, who only joined to push for Brexit, start to drop away. The balance of local associations could shift, giving Johnson more leeway to negotiate a softer Brexit, based upon membership of, or alignment with, the Customs Union and Single Market. 

But, an external whip on the direction of travel of the Tories will be the financial markets. Even a lack of indication that Johnson intends to get a deal that ensures continued alignment will increasingly be the cause of speculators attacking the Pound. There will, of course, be fluctuations, but, in the coming months, expect to see the general direction being in a downward direction. A lower Pound gives the financial markets greater influence over government policy, because it means that any misstep can be followed by a sudden drop to levels that create problems for the government. If the Pound continually falls, it means that imported inflation rises, at a time, when any rise in global economic growth will cause global prices to rise, putting additional pressure on costs. Wages are currently rising faster than prices due to increasing labour shortages, and low levels of productivity growth. Imported inflation due to a falling Pound, will put even more pressure on wages to rise. 

A falling Pound, rising inflation, rising wages squeezing profits means that UK interest rates would be pushed higher. Higher interest rates means that asset prices fall. In the case of the UK, the large proportion of the FTSE 100 comprised of firms that make their profits overseas distorts the reality. A falling Pound inflates the sterling value of these foreign earnings, which boosts the UK price of the shares of these companies. That is why when the Pound falls, the FTSE 100 often rises. But, that does not apply to the FTSE 250, or the indices of UK share prices for a larger number of companies. Even companies that make a large amount of their profits from exporting do not get this effect. They continue to have to face increased costs in the UK. In fact, its an incentive for other UK based companies to shift their production overseas so as to obtain the same kind of benefits that say an oil producer obtains from having its operations based in other countries, but its profits repatriated in sterling. 

The UK based companies that export gain a competitive advantage in their export markets if the Pound falls, and they keep their sterling prices constant, because that means that the Euro, Dollar, or Yen prices of their products fall. But, this is a bit of a delusion. Yes, the export price of British goods falls, but that means that more of them now have to be sold to obtain the same amount of foreign currency earnings, which means that British workers have to work harder to produce this greater quantity of products, and British capitalists get only the same amount of profits in real terms, but for having to have sold more products, and undertaken more expense. The devaluation actually means that an hour of British labour now produces less value than an hour of foreign labour by comparison. 

Put another way, the £100 that British companies make from selling products to the EU, now only buys, say, 90% of the EU products that previously could have been bought before the value of the Pound fell. The immediate importance of that is obvious. Many of those UK companies must themselves buy EU products as components of their own products. In addition, they must buy foreign produced energy, minerals and so on. The sterling price of all these inputs will have risen, due to the fall in the Pound. So, unless they accept lower profits and profit margins, they cannot keep their export prices the same, because their own costs have risen. Similarly, British workers who buy foreign cars, go on foreign holidays, buy British made products that contain foreign produced inputs, and who buy foreign produced oil, gas, food etc., will see the prices of all these things rise, so that unless their wages rise accordingly, their living standards will fall. Moreover, price of production is cost of production plus average profit, and so, if British companies see their cost of production (expenditure on machines, energy, materials etc., as well as expenditure on wages) rise, but their prices do not rise proportionately, then that can only result in the UK rate of profit falling. That means that capital, which today is highly mobile, will leave the UK, and move overseas to where it can make the average profit or better. 

Even for capital that can't move overseas these falls in the rate of profit means that they become more dependent on borrowing capital than on their own profits. That means that pressure is put on for interest rates to rise. Already many small and medium sized companies have difficulty borrowing money, and where they can they face high rates of interest, which is in stark contrast to the yields on government and corporate bonds, and low rates for borrowing for financial and property speculation. Higher interest rates will put tens of thousands of small businesses into liquidation. But, it also means that the government will face increased problems in raising finance through taxation. It too will have to borrow more, particularly given Johnson's promises to large parts of the country. 

In the last year, we have seen the continued decimation of the high street, as the excess number of retailers created in the 1980's, 90's and early 2000's find that they can't each get enough customers, particularly as those customers are now moving increasingly online. Even with recent doses of QE to reflate asset prices, house prices have failed to rise sharply, and in much of Britain, today, they are falling. In London that is most clear. But, as retailers also close at a rapid pace, its not just house prices that are falling. Commercial property prices are also falling, as witnessed by the closure of a number of open ended property funds, that were unable to meet the redemption requests from their subscribers, without having to engage in a property fire-sale that would have collapsed commercial property prices. Even a modest rise in interest rates will spark a sharp drop in property and land prices. 

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