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Sterling has seen a substantial weakening in the past week or so, losing some 3.5 per cent of its value following the deterioration in the EU/UK relations over the Withdrawal Agreement. This

was made all the worse by the government stating that the UK would “prosper mightily” with or without a deal, raising again the prospect of a no-deal Brexit at the end of the transition

period on December 31st. ING analysis released this weekend suggested that although a certain risk premium is already built into sterling’s valuation, that may not be large enough. According

to Nomura the cost of hedging and protecting investors against sterling’s future ups and downs has “risen to levels only seen during periods of Brexit stress or Covid-19 market madness.”

That the markets are worried is understandable. The economic picture after no-deal would be bleak. The long term  Brexit costs to the economy could easily exceed those of the current Covid

crisis. The UK has had its credit rating downgraded three times in the last ten years. One occurred at the time of the financial crisis, and this was due to the large role played by the

financial sector in the UK’s economy compared to many other countries. Then just after the Brexit vote in June 2016 another downgrade came as the markets reassessed how the UK would perform

outside the EU. And finally, at the beginning of the Covid lockdown came another downgrade due to worries that the UK would suffer more than others from a closure of its service dominated

economy. There are now rumours of a further downgrade. In each case, the currency markets have reacted to Britain’s weaker economic outlook by marking sterling down. There were devaluations

of 20-25 per cent in 2009 and then again in 2016. The rate has been pretty volatile since, to a considerable extent mirroring progress — or otherwise — in negotiating the UK’s future

relationship with the EU. More recently the disproportionate impact of the Covid crisis on the UK economy has combined with worries about the lack of progress on the EU/UK trade deal. Does

it matter that sterling is under pressure? At the very least it shows that the standing of the country is diminished in the eyes of investors, who will be moving money to safer havens. A

lower pound may also raise inflation, but this is unlikely to be severe, given the general deflationary pressures in the world economy. Will it helps exports? In the short term maybe not

that much, given the current weakness in world trade and recent UK devaluations have not seen a sustained improvement in the trade balance. But it may mean that exports don’t fall as much as

they otherwise would and they may do better in the long term. And even if firms try to offset part of the currency decline by raising prices rather than increasing sales, that would improve

sterling profits and keep more workers on the payroll. This is exactly what we saw during the financial crisis and it stopped many firms from going under. In truth the economic fundamentals

are stacked against the UK. Years of under-investment, especially since the financial crisis have left the UK behind in the global innovation and productivity race. The Economic and Social

Research Council is investing £34m in a new Productivity Institute to look at ways to improve the nation’s performance. In relation to the problem it seeks to address, it is only a small

sum. Absent any immediate industrial strategy, the Institute’s findings, once they appear, may take too long to implement — or be scuppered by the politics of the time. A solution to the

UK’s lack of competitiveness is urgently needed and a weak pound may offer some interim help. This is not to suggest that one should actively seek a competitive devaluation and it doesn’t

offer the solution to all of the UK’s problems. But we have come a long way from the time when active foreign exchange intervention made any sense. Given the current weak UK fundamentals the

markets can be left to do the necessary currency adjustments themselves.