This is not to lightly dismiss Bank of America’s analysis, which raises significant concerns about the pound’s continued credibility as a reserve currency. The obvious failures of the Bank of England’s inflation-targeting regime have left policymakers in the odious position of having to raise interest rates in a rapidly slowing economy – never very pretty and often symptomatic of a downward currency spiral.
As Bank of America’s Sharma points out, this makes the Bank’s position significantly different from that of the US Federal Reserve, which is raising interest rates amid a still-strong economy. Rightly or wrongly, the independence of the Bank of England has also been questioned. Too often it seems to be a creature of the government’s need for deficit financing.
But the Bank’s credibility is only half of it. Since Britain left the European single market, there has been a noticeable deterioration in the country’s external trade position, bringing to mind memories of previous balance of payments crises.
Even a growing trade deficit doesn’t really matter as long as there are enough capital inflows to finance it. But if these start to decline, the currency is going to be in trouble.
For much of last year, while there was a general perception that UK assets were undervalued relative to their peers, this was not really a problem. Money flowed in as needed and the exchange rate actually appreciated somewhat.
But that undervaluation may have disappeared, and with interest rates rising more or less everywhere, UK assets may have lost some of their comparative appeal.
Global liquidity conditions are deteriorating and, with the normalization of interest rates, net cross-border flows have slowed. With such a large current account deficit, Britain is particularly dependent on “the kindness of strangers”, and therefore vulnerable to any loss of international trust.
All of this is undoubtedly true. Brexit has made trade with Europe, still the UK’s biggest external market, more difficult and costly, while the UK government has so far failed to demonstrate significant economic gains to offset .
Moreover, the government’s refusal to acknowledge that Brexit played a role in the deterioration of trade only escalates the situation further, giving the impression that ministers have their heads in the sand.
But this is where it is reasonable to challenge Bank of America’s analysis. Everything is relative in the currency markets, and looking around the world today, you would be hard-pressed to find a jurisdiction where things look significantly better.
Ruled by an indecisive geriatrics, crippled by an increasingly dysfunctional political system, and torn apart by the poison of its culture wars, the United States looks increasingly unattractive beyond its traditional attributes as a reserve currency.
The EU? Slow and badly compromised by its 27 moving parts, it is more exposed than any other to the debilitating effect on energy prices of the war in Ukraine. Moreover, with rising interest rates, the Eurozone debt crisis will be back before we know it. Spreads are already widening worryingly.
As for China, what the hell is the regime playing at? The anti-Western rhetoric alone would be enough to deter all but the bravest investors. Add to that the zero-Covid debacle, the crackdown on tech, the education sector, Hong Kong and Uyghurs and you would reasonably conclude that China’s economic miracle is over.
Anyway, compared to the alternatives, the UK doesn’t seem like such a bad place for your money. Witness the great outpouring of affection for the monarchy, its institutions still seem relatively robust, and although the fiscal situation appears precarious, it is by no means irrecoverable.
True, there is no discernible strategy behind the current chaos of intellectually bankrupt policy-making, but that seems to be the case more or less everywhere. Can it really be so difficult for a Conservative government to provide the pragmatic and predictable policy framework that is needed for business to thrive? Sort that out, and so would the British pound.