The Telegraph: May’s deal won’t help a struggling sterling

Figures released just before Christmas show the UK’s current account deficit widened to £26.5bn between July and September 2018. This shortfall of goods and services exports over imports amounted to 4.9pc of GDP, bigger than the previous quarter, but an improvement on the UK’s net trade position immediately after the June 2016 Brexit referendum.

Part of this latest current account deterioration reflects higher profits at foreign-owned British-based firms, some of which then flow overseas. While this scores negatively in the trade figures, it is still positive news.

Also, Britain’s budget deficit narrowed to £7.2bn in November, the lowest monthly shortfall of government revenue over receipts since November 2004. So far during this fiscal year, the deficit is 30pc down on the same period in 2017, a marked improvement.

Ordinarily, these kind of considerations – trade flows and sovereign borrowing needs – help determine the ups of sterling. Since Britain triggered Article 50 in March 2017, though, and particularly over recent months, the pound has been driven largely by Brexit. The UK currency seems immune from economic data, swinging instead on any political news, rumour or innuendo relating to Britain’s EU departure in 11 weeks’ time.

The prevailing wisdom is that sterling could rise significantly during 2019, as and when Brexit uncertainty is dispelled. In trade-weighted terms, the pound does indeed look 15-20pc undervalued.

Sterling hit lows of $1.25 last month, as Theresa May postponed the “meaningful vote” on her Withdrawal Agreement and Parliament went into meltdown. Yet the long-term fundamentals suggest the UK currency should be stronger, against both the dollar and euro.

The pound will stay shackled to Brexit-related politics at the very least until the end of March – when we’ll leave the EU either under Theresa May’s deal, an improved deal following EU concessions or “no deal”. That’s unless Article 50 is extended – in which case, all bets are off.

The now openly anti-Brexit faction across Britain’s political class – “I respect the referendum result, but …” was always disingenuous nonsense – could force the Government to stage a second referendum.

That would take time – meaning, again, Article 50 will need extending, something Brussels will no doubt miraculously engineer if it increases the chance of the UK (and our massive annual contributions) remaining in the EU.

Alternatively, of course, May’s ramshackle administration could fall, leading to a general election – and further months of chaos. It could well be a long time, then, before Brexit uncertainty dissipates and economic fundamentals returns as the main driver of our national currency. Until then, sterling predictions are largely political guesswork.

The dollar last week rallied from three-month lows, after Jerome Powell, the Federal Reserve chairman, said the US central bank will implement more “quantitative tightening”, further shrinking its balance sheet after years of emergency expansion following the global financial crisis.

What sent stocks on Wall Street soaring was Powell’s assurance he’ll show “patience” when adding to the nine rate rises since late-2015, four since he took over from Janet Yellen last February. US rate rises, then, could now be on hold, with the Fed holding fire as and when financial markets wobble. That’s why they could weaken throughout 2019.

Similarly, the euro may depreciate over the coming year. Sterling is trading close to €1.11, compared to around €1.26 during the months before the 2016 referendum. That’s historically low, despite UK rates since rising twice, and lately growing faster than the eurozone. German industry is in recession, the Italian economy is shrinking and French growth has stalled.

Yet these factors are barely reflected in the current euro-sterling valuation, given the market’s fixation on venal Westminster politics and Brexit-related doom-mongering.

As and when the Brexit air clears, then, the pound should rise against the currencies of its two main trading partners – both the US and the eurozone. That would reduce price pressures, via cheaper imports, easing the cost-of-living for millions of households. But, again, that’s unlikely to happen soon.

Sterling rose last week, after the Government failed to block two highly controversial amendments designed to frustrate leaving with “no deal”, trading with the EU under World Trade Organisation rules instead. There is a widespread view, relentlessly promoted by the Treasury and broadcasters, that moving to WTO rules will maximise uncertainty, resulting in economic meltdown.

That is completely wrong. Those watching closely will know that, one by one, the “no-deal” scare stories – drug shortages, massive delays at Calais, planes won’t fly – are being trumped by reality. As governments across the EU move to prevent a mutually destructive outcome, interim “no-deal” plans are falling into place.

Given where we now are, “no deal” in fact provides the maximum possible certainty. Moving to WTO rules is as unambiguous as this bungled Brexit can now be. In my view, once it’s clear WTO rules are fine, and there’s no meltdown, leaving on these terms would then unlock considerable investment, before the UK signs a single new international trade deal.

Many currency traders believe the most likely scenario is that May’s deal eventually gets through Parliament. Once she loses the vote scheduled for this week heavily, the argument goes, Brussels will make concessions – particularly on the Irish backstop. Faced with the danger of a Corbyn government, Tory rebels will then relent in sufficient numbers for May’s deal to pass.

This could happen. I don’t think it will but even if it does, it’s not as if Brexit uncertainty then abates. On the contrary, the UK would then go into a period of ghastly “future arrangement” negotiations, constrained by EU diktat at every turn. That, I believe, would bring prolonged and even more serious political and market turmoil, not least as Britain would find itself in an arrangement so one-sided we could end up walking away from an international treaty.

The currency markets are right that sterling is undervalued. But they’re one hundred per cent wrong to think May’s deal will clear the Brexit haze.

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