Why is the pound proving resilient after Brexit?

The sterling is up by nearly 6% in trade-weighted terms 

To many, Brexit has been going about as badly as feared. And trade is worse, business costs have increased, lower inward migration has reduced labour supply, the number of new trade deals is lower than the government promised, and more. In terms of trade, exports to the EU fell by 12% in 2021 in comparison to 2018, while those to non-EU countries fell by a much more modest 6%.

Given that the UK achieved a tariff-free deal with the EU, there should have seemingly been no reason for exports to the EU to have fallen by more than non-EU trade. The fact that they have gives weight to the claims of exporters that doing trade with the EU has become much more difficult and more costly due to customs checks and more. This trade difficulty shows up on the import side because imports from the EU have fallen by 17% over the same period, while there has been a 13% rise in imports from non-EU countries. Although that might appear positive, eurosceptics would probably argue that getting more imports from outside the EU is increasing domestic prices at home, thus adding to the inflation problem.

It certainly seems to be the case that many organisations that try to independently measure the cost of Brexit are still taking a pretty negative view, with no signs of improvement in estimates now compared to those made before Brexit started. For instance, the Office of Budget Responsibility (OBR) still argues that exports and imports will both be around 15% lower over the long haul compared to the levels that would have existed had the UK remained a part of the EU. It also estimates a 4% hit to productivity.

On a more anecdotal level, Mr. Steve Barrow, Head of Standard Bank G10 Strategy can see that Brexit is struggling. UK Brexit ministers have been on a conveyor belt since the 2016 referendum, with Lord Frost the latest to resign and jump off. And polls on public opinion generally show that more than half of respondents’ rate Brexit as a failure so far.

All of this raises the question of why sterling has not suffered. Mr. Steve Barrow thinks part of the reason is that the pound fell hard when the referendum decision was announced back in June 2016 and, even though the pound rose last year, it is still not back to pre-referendum levels. In other words, the market viewed Brexit as bad news, priced it accordingly and, so far at least, seems to have been proved correct. Another factor is that the "cheapening" of the pound after the referendum made UK companies attractive from an M&A standpoint. The result has been a flood of cash into UK companies, and that’s possibly helped the pound to hold firm.

"COVID-19 has surely been a factor as well. For while, we might pin the UK’s labor supply problem on fewer EU nationals coming to the UK because of Brexit, the slowdown has clearly been caused by Brexit as well. Supply chain pressures also fall under the same umbrella. Hence, it has been hard for investors to determine the true damage done by Brexit. Yet another explanation is that Brexit and its impact on things like trade, productivity, and more is not actually all that important for the value of the pound. Of far more importance, for instance, might be the setting of monetary policy, and if Brexit causes the base rate to be higher than it otherwise would be, because import costs lift inflation, for instance, then we might argue that Brexit is actually good for sterling, not bad", Mr. Steve Barrow stressed.

In the end, Mr. Steve Barrow can only guess at the reasons why the pound is proving resilient. This being said, he is not surprised that it has held up. He had always assumed that the market had priced in a pretty bad Brexit after the referendum and that the post-referendum period would see a slow recovery process. "We think this is still ongoing, which is one reason why we see sterling/dollar pushing on to 1.50-plus and towards 0.80 against the euro," Mr. Steve Barrow said.