16 Oct 2016 Why the pound is sliding

If you are earning an income or a pension in sterling, you are already feeling the pinch of a weaker British pound. At the time of writing, sterling was 18.3% weaker against the euro than on January 1 and 17.6% weaker than exactly a year ago.

The key vulnerability for the pound is the large current-account deficit. This is essentially the gap between what the UK exports to the world in goods and services (plus a few other items like earning profits from abroad) and what it imports. Since there is less demand for stuff that will be paid in your currency (exports) than for stuff that will be paid for in other currencies (imports), there is less demand for the pound, making it less valuable. Under these circumstances (and other things being equal), the pound weakens against other currencies.

The UK economy normally offsets this effect with inflows into what is called the financial account. These financial flows are people from abroad parking their money in UK banks, investing in UK companies by buying shares on the stock exchange or taking stakes in other businesses, buying property or buying the debt of government and companies.

In 2015, these two categories were balanced for the UK: the current-account deficit was 5.4% of GDP but this was offset by a financial account surplus (including reserves) of 5.4% of GDP.

However, two things have changed since the Brexit referendum. First, the current-account deficit has widened, reaching about 5.9% of GDP in the second quarter. At the same time, the financial account surplus has shrunk to about 3% of GDP. This weakens the pound.

Second, rightly or wrongly, the foreign-exchange markets have interpreted statements by Prime Minister Theresa May to mean that the UK government is happy to sacrifice financial services as it leaves the EU. In short, restricting immigration seems to be higher on the priority list than ensuring that London keeps on attracting money and talent from abroad.

This means a sharp drop in the amount of money flowing into the City, an even bigger gap between the current-account deficit and the financial account surplus and, therefore, more trouble for the pound.

There is no doubt that the UK economy has become unbalanced: too dependent on money that sloshes into London and not enough on manufacturing and other services in other parts of the UK.

A slow rebalancing of the UK economy could make it stronger. It may even help heal some of the ugly national divide that now plays out daily on social media.

However, a sudden rebalancing will mean higher prices for food and other imported goods, more expensive holidays and quite likely a slide into recession as people spend less on nice-to-haves. Worse still, it will mean the government has less tax revenue to do anything about it.