Sterling falls and inflation returns

Sterling falls and inflation returns

The recent 18% fall in sterling versus the US dollar, and similar fall versus the Euro, since the referendum up to mid-October, will cause problems for Britain in the coming months.

We currently have a current account deficit of more than 50% of our Gross Domestic Product (GDP). This means we import significantly more goods than we export because, within our trade figures is a surplus in services (e.g accounting, architecture, banking and legal services).

The government currently spends more each year than it has in tax income, and we have a 0.25% interest rate. Altogether, the British economic outlook, during this uncertain period due to the Brexit vote, will have a real impact on everyday life for most people.

This is because inflation is coming back. It is more than 40 years since we were in the midst of an inflationary spike coupled with a budgetary mess similar to today. Eventually the International Monetary fund had to be called in with an emergency loan to assist in the restructuring of the UK economy.

Inflation at the time was more than 20%, as prices soared. Not since World War I had the problem been so severe.

Economists responded with the invention and application of monetarism, which meant that, by controlling the money supply (i.e. interest rate policy), one could prevent the damaging effects to people’s spending power and stop inflation wrecking the economy again.

After the recent devaluation, and considering that we now import more than we export, inflation will rise. Our avocados, pineapples and cars will become more expensive.

We will of course prioritise our expenditure, focusing on paying the mortgage, rent, food bill and utilities. The drop in discretionary expenditure (holidays, etc.) will likely tip the British economy into recession.

Coupled with Brexit, the drop in foreign direct investment into the British economy will make the current account deficit worse. But will the Bank of England raise interest rates to defend the pound? That could make any recession worse, but is probably unavoidable.

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