Will the 1970s sterling crisis happen again?

The British pound's value versus the US dollar hit an all-time low.

>> UK's inflation pressure and impacts on GBP

An energy crisis, surging inflation, soaring interest rates and a dramatic “go for growth” fiscal gamble by the government. Sound familiar? To many, it describes current UK developments to a tee. But what we’re actually talking about here is the UK in the early 1970s. The problem is that if this turns out to be the template for today it won’t end well. In the UK, it ended with a sterling crisis in 1976 and a USD3.9bn loan from the IMF to avert a deeper balance of payments crisis.

The closest historical precedent to today lies in the 1970s with its oil price shocks, surging inflation and economic recessions. In the UK, all that’s been missing is reckless fiscal pump priming by the government as we saw in 1972 when the then Chancellor Barber announced a huge fiscal package to try to generate 10% growth over the next two years.

Not only did it fail in that respect, it failed in every other as well helping to drive the economy to the wall and into the arms of the IMF. Fast forward to today and it looks as if the new Truss-led government is trying out the same fiscal largesse. Tax cuts costing GBP45bn over the next five years have only been exceeded once before (in like-for-like terms)- by the Barber budget in 1972.

From the time of the budget in 1972, the pound lost close to 40% of its value over the next five years and it was not as if interest rates were coming down. They went up from 5% at budget time to a peak of 13% and were still over 10% five years after the budget. Now, of course, a lot has changed since then. The Bank of England (BoE) is in charge of monetary policy not the government as it was back then.

But is the BoE showing a steely determination to reduce inflation? It does not look like it to us. What’s more the present government has already shown that it is prepared to meddle with the Bank’s operation– at least in the area of regulation – despite insisting that its independence is sacrosanct.

So, the question today is whether the extraordinarily expansive budget, which comes atop the huge fiscal spending on freezing household energy bills (GBP60bn over the next six months) will provoke another sterling crisis? Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said he is not sure, but such is his concern for the way that fiscal and monetary policy are jarring against each other that he feels it is correct to both lower his sterling forecasts and, more notably, lift his forecasts for gilt yields and base rates.

>> Will GBP get a lot worse?

For while the UK probably won’t get into the pickle it got into in 1976, when it had to go the IMF for a loan, there’s a real danger here that the weakness in the pound and gilts will force the BoE into rate hikes that are primarily designed to restore market confidence and not just bear down on inflation. That’s not happened for a long time. The last such occasion was in 1992 when the government had to raise rates sharply to defend the pound’s position in the Exchange Rate Mechanism (ERM); an endeavour that ultimately failed.

There is an alternative possibility – as there usually is. For since the sharp fiscal easing and monetary tightening in the UK during the early 1970s we have seen the US embark on a similar policy combination under former President Ronald Reagan and former Fed Chair Volcker in the early 1980s – but this led to a massive surge in the dollar (perhaps one that’s proving a template for today’s rise given similar fiscal and monetary policies). But the US is the US and, unfortunately, the UK is the UK.

“For even as far back as the 1970s the pound had lost its dominant global role and this made it far more vulnerable to balance of payments crises and runs on the pound compared the dollar. The greenback is propped up by its global dominance in areas like international lending, trade invoicing, currency reserves and more. Hence, the idea of a run on the US dollar seems a little far-fetched, but it certainly does not seem so far-fetched when it comes to the pound”, said Mr. Steve Barrow.