Could the value of the pound drop to just one US dollar?
With Boris Johnson taking over for Theresa May as British prime minister, it’s a question investors are beginning to ask as the risks of a chaotic Brexit rise.
Johnson has said the United Kingdom must leave the European Union by October 31 with or without an agreement to protect trade with the country’s biggest export market. A “no deal” Brexit would trigger a recession and cause the pound to nosedive, according to official forecasts. Some experts say the pound and dollar could even reach parity.
“It’s something that could happen over time,” said Lukman Otunuga, a research analyst at currency brokerage FXTM. “It’s going to be a long and painful grind all the way to October 31.”
Analysts warn that a precipitous decline in the value of the pound would cause inflation to spike, hurting consumers. And while it might help exporters, a collapsing currency could scare off foreign investors and make life difficult for British companies that have to make payments in dollars.
Right now, the pound is trading below $1.25. It was at nearly $1.50 before the 2016 vote on Brexit.
Experts predict that Johnson’s election as Conservative Party leader and the approaching October deadline will together continue to push sterling toward $1.20, and possibly lower.
“The risk of the UK leaving without a deal is going up by the day,” said John Wraith, head of UK rates strategy at UBS. “There’s this … magnet drawing sterling lower, just because time is shortening.”
Wraith said the most likely outcome is still that Britain strikes a deal to leave the European Union that mitigates the impact on trade. But a 20% decline for the pound to parity with the dollar is “certainly not inconceivable,” he continued.
Analysts at Morgan Stanley agree. In a recent note, they said that the pound could fall to between $1.00 and $1.10 if Britain leaves the European Union without a deal in place. Even if Johnson just takes a tough negotiating stance with Europe, sterling could trade between $1.10 and $1.20, they added.
The lowest level the pound ever reached was $1.05 in 1985, when the dollar shot up during the Reagan administration. The same year, the United States, the United Kingdom, Germany, France and Japan signed on to an agreement known as the Plaza Accord to rein in the dollar’s rise.
Inflation could double
A harsh Brexit is expected to have severe economic consequences in the near term.
The UK Office of Budget Responsibility says it would cause a recession. GDP would shrink by 2% by the end of 2020, and the UK government would be forced to borrow an extra £30 billion ($37.4 billion) per year, according to the budget watchdog.
The devaluation of the pound would add to the mess. Imports would become more expensive, causing prices to rise. Wraith said that if pound-dollar parity happens, inflation would probably double, reaching between 4% and 5%.
Some experts argue that a weaker pound would help the economy get back on track. A falling pound boosts tourism to the United Kingdom and helps makes exports cheaper, the argument goes. British businesses could also sell more at home as the price of imports goes up.
But tourism makes up less than 10% of GDP, while exports contribute roughly 30% to GDP.
The ‘kindness of strangers’
Another problem is that many UK businesses still have to make dollar payments, and their costs would rise sharply. British billionaire Richard Branson told the BBC earlier this month that parity with the dollar would be “devastating” for Virgin companies, such as the Virgin Atlantic airline.
“All our costs are in dollars,” Branson said. He went on to say that Virgin would invest less in the United Kingdom as a result.
Should the falling pound undermine confidence in the UK economy among foreign investors, it could spark concerns about Britain’s current account deficit, or the amount it borrows from the rest of the world.
That deficit, which is sizable by international standards, reached £30 billion ($37.4 billion) in the first quarter of 2019, or 5.6% of GDP.
Bank of England Governor Mark Carney has cautioned that if the confidence of foreign investors, or the “kindness of strangers,” dwindles in the wake of Brexit, then Britain could struggle to fund domestic expenses.