E Weak Pound, A Net Negative For UK Economy?

A survey released by the payment company Visa earlier today showed the growth in UK households’ spending in Jan to Mar period was the weakest since the end of 2013. The main culprit was inflation.

Spending on traditional retail sectors dropped. Online spending was up by 8.2% annually in March, while face-to-face spending on the high street was down by 1.3% annually. This is another bad news for high street retailers and good news for online retailers like Asos.

The drop in the consumer spending, though not alarming, shows the Brits are feeling the pinch of higher imported inflation (fuelled by weak Pound). That could act as a drag on the GD. Optimists believe the drag on GDP due to weaker consumption could be more than offset by a rise in exports/narrowing of the trade deficit. However, there is no evidence of a correction in the trade situation. The ONS data released on Friday showed the visible trade deficit increased unexpectedly to a five-month high of GBP 12.46 billion. So is the weak Pound acting as a net drag on the economy? Berenberg Economist Kallum Pickering, during his interview with Tip TV, stressed that it would take an inflation print off more than 3% to push spending significantly lower. 

Whatever happened to the J-curve theory…?

The ‘J curve’ refers to the trend of a country’s trade balance following a devaluation or depreciation under a certain set of assumptions.

It says that a country’s trade balance initially worsens following a devaluation or depreciation of its currency. This is logical since importers worried about a further slide in the currency boost/pre-pone purchases. Meanwhile, foreign importers/buyers delay purchases on speculation the currency of the exporting nation would drop further.

Once the currency starts stabilizing, the foreign demand (exports for home country) rises at a faster rate. However, economic theories are never straight forward and always depend on assumptions.

One such assumption in the J-curve theory must be – healthy global demand. However, we are facing a savings glut and every other economy is trying to compensate for the weak domestic demand by pushing up exports (importing foreign demand via weak currency). Hence, the J-curve theory isn’t applicable here. It is unlikely that the drop in the Pound post-Brexit referendum would help reduce the UK’s trade deficit in a big way, but it will/and is surely pushing inflation higher.