Was the Pound Ready to Get Walloped?
Even before the Brexit vote was in, analysts were decrying the overvaluation of the British Pound. Here Gary Howes at poundsterlinglive.com writes before the vote:
The British pound may rally on the outcome of a Remain victory to the EU referendum, but ultimately the move could prove fleeting.
This is according to two prominent research institutions – Morgan Stanley and Capital Economics.
“In our opinion, GBP is overvalued as GBP-supportive interest rate and yield differentials are inadequate to help to fund the UK’s 7% GDP current account deficit,” say Morgan Stanley in a brief to clients.
The current account deficit has been a concern for many economists who have been trying to forecast the value of the pound.
Typically an exchange rate between two countries is set according to the trade relations between them.
An importer would have demand for the currency of the exporting country – and if we look at the UK’s trade balance we can see the UK is clearly a net importer.
Therefore, it has a greater demand for foreign currency than does its counterpart which would mean the value of the currency must ultimately fall according to principles of supply and demand.
However, sterling is priced higher than this trade-based dynamic because foreign investors pour money into UK-based investment opportunities.
Thus, the exchange rate is higher than the level implied by trade dynamics.