Sterling hit a record low last week as the UK’s new government’s tax cuts spooked markets. A strong dollar is an important factor – but the blow to the UK economy from Brexit set the stage for defeat. Brexit has shaken confidence in the UK as a promise of security, further shaken by sudden tax cuts.
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The pound’s plunge over the past week has been seen as a story of a stronger dollar – but dig a little deeper and the long-term implications of Brexit become clear.
Strategists pointed to Britain’s exit from the European Union as the main cause of the fall in stock prices as markets were angered by the new government’s promise of tax cuts.
Analysts said Brexit fueled a sustained slide in the pound well before the pound fell to a record low on Monday. It hit the country’s labor market and trade, leading to a rise in inflation – seriously affecting the UK’s economic health.
Oanda market analyst Craig Erlam told Insider: “Brexit will always have a negative impact on the economy and the pound in the years after you leave.”
“It is impossible to quantify the role of Brexit in sterling’s depreciation over the past six years. But it’s clear he hasn’t done the UK economy any good so far,” he added.
Dollar strength and sterling pain
The strength of a country’s currency is often taken as an indicator of its overall economic health.
Sterling fell to an all-time low of $1.0350 on Monday as investors were spooked by new UK Treasury Secretary Kwasi Kwarteng’s promise to cut taxes as Britain grapples with inflation at 9.9%.
A key factor is the strength of the US dollar, which has risen against most currencies this year. The historic rise in the US Federal Reserve has made the US dollar more attractive to international investors and increased its value.
But the pound has fallen steadily against the dollar over the past six years, down more than 23% from the previous day’s $1.44. June 2016 Brexit ReferendumIt fell to $1.33 within just two weeks of the vote.
The tumultuous prime ministers of Theresa May and Boris Johnson – and the coronavirus pandemic – have fueled economic uncertainty since the vote.
Now that uncertainty has deepened as the spending plans pushed by staunch Brexiteers Liz Truss and Prime Minister Kwaten drew criticism from the International Monetary Fund and rating agency Moody’s.
Lawmakers in his own party have also opposed the proposals, which are seen as likely to boost inflation and run counter to the Bank of England’s monetary tightening policy. The Bank of England itself stepped in and started buying long-dated government bonds to stabilize the markets and the situation.
Brexit has shaken international confidence in the UK economy, opening the door for a pound slump and a meltdown in financial markets this week. Investors have further lost faith in the UK as a safe bet amid fears the tax cuts will wreak havoc.
SEB analyst Ole Hvalbye said Britain was heavily indebted, had chronic fiscal problems and struggled during the 2008 financial crisis. “Since then, British politicians have worked hard to make the situation worse,” he wrote in a report.
The impact of Brexit
One reason why Brexit has hurt the UK economy since Brits voted to leave the EU in 2016 has been a sharp drop in immigration from the EU. This has led to significant labor shortages, particularly in healthcare, hospitality and academia.
“The UK labor market is a flagship of Europe: flexible, low unemployment and productive labor migration,” said Hvalbye. “Brexit – that’s a political position, not an economic position – has changed the situation.”
“Despite weak growth, we have seen the consequences of lower labor force participation and relatively rapid wage increases,” he added, referring to economic growth.
Rising wages tend to fuel inflation, which weakens the pound as its purchasing power falls.
Meanwhile, Britain is struggling to renegotiate a key trade deal with the European Union. With the country heavily dependent on imports from trading blocs, food and gas prices have risen – leading to a bleak inflation picture.
Investments also fell sharply, according to August data, as economic uncertainty prompted companies to rein in spending. Institute of Directors.
The Resolution Foundation think tank last year warned Britain should brace for a decades-long recession Brexit etc.
Read more: GBP/USD just hit an all-time low. That could push up food and gas prices for already struggling households.
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