How Brexit is at the heart of Britain’s currency rout

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  • The pound hit an all-time low last week as the new UK government’s tax cut plans spooked markets.
  • The strength of the US dollar is an important factor, but the Brexit blow to the UK economy has set the stage for rout.
  • Brexit has shaken confidence in the UK as a safe bet, and the brutal tax cuts have further shaken confidence.

The crash of the pound sterling last week is seen as a story of US dollar strength – but dig deeper and the lasting impact of Brexit emerges.

As markets fretted over promises of tax cuts from the new UK government, strategists pointed to the UK’s withdrawal from the European Union as one of the root causes of the fall.

Brexit was fueling Britain’s long-term decline long before it slumped to a record low on Monday, analysts said. It has hit the country’s labor market and trade and contributed to rising inflation – weighing heavily on the UK’s economic health.

“Brexit was always going to be negative for the economy and the pound in the years immediately after he left,” Oanda market analyst Craig Erlam told Insider.

“It is impossible to quantify the role of Brexit in the devaluation of the pound over the past six years. But it is clear that so far it has done the UK economy a disservice,” he said. -he adds.

The strength of the dollar against the pain of the pound

The strength of a country’s currency is often considered an indicator of its overall economic health.

The pound fell to an all-time low of $1.0350 on Monday as investors spooked by promises from Britain’s new finance minister Kwasi Kwarteng to cut taxes at a time when the UK is struggling against inflation of 9.9%.

An important factor is the strength of the US dollar, which has appreciated against most currencies this year. Historically large interest rate hikes by the Federal Reserve have made the greenback more attractive to international investors, driving up its value.

But the pound has fallen steadily against the dollar for the past six years, slipping more than 23% from $1.44 on the eve of the June 2016 Brexit referendum. It fell to 1, $33 in just two weeks after the vote.

Since the vote, the turbulent prime ministerships of Theresa May and Boris Johnson – as well as the coronavirus pandemic – have helped fuel economic uncertainty.

Now that uncertainty has intensified, the spending plan promoted by Prime Minister Liz Truss and Kwarteng – both staunch Brexit supporters – is drawing criticism from the International Monetary Fund and ratings agency Moody’s.

Lawmakers from their own party have also spoken out against the proposals, which are seen as likely to drive up inflation and run counter to the Bank of England’s monetary tightening. The BoE itself stepped in to start buying long-term government bonds to stabilize the markets and the situation.

Brexit has undermined international confidence in Britain’s economy, setting the stage for the pound to fall and financial markets to rout this week. Investors have lost further faith in the UK as a safe bet, fearing tax cuts will cause disarray.

SEB analyst Ole Hvalbye said the UK was deeply in debt and suffered from chronic fiscal problems, and had struggled during the 2008 financial crisis. “Since then, UK politicians have worked hard to make the situation worse,” he wrote in a note.

The impact of Brexit

One of the ways Brexit has hurt the UK economy is the significant drop in immigration from the EU since Britons voted to leave in 2016. This has created major labor shortages workforce, particularly in healthcare, hospitality and science.

“The UK labor market was a flagship in Europe: flexible, low unemployment and with productive labor immigration,” Hvalbye said. “Brexit – which is a political position, not an economic one – has changed the conditions.”

“We are already seeing the consequences of this with lower labor force participation and relatively rapid wage growth, despite lackluster growth,” he added, referring to economic growth.

Rising wages tend to fuel inflation, which weakens the pound as its purchasing power declines.

Meanwhile, the UK is struggling to renegotiate key trade deals with the EU. As the country relies heavily on imports from the trading bloc, food and gas prices have risen, contributing to grim inflation.

There was also a significant decline in investment as economic uncertainty prompted companies to cut spending, according to August data from the Institute of Directors.

The Resolution Foundation think tank warned last year that the UK should brace for a decade of economic decline due to its departure from the EU, among other factors.

Read more: The pound sterling has just fallen to a record low against the dollar. This could drive up food and gasoline prices for already struggling households.

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