How low can sterling go?

Sterling has fallen sharply in the past year, down by 20% on the trade-weighted index. The fall against the dollar and the euro has been as deep or deeper, with depreciation of 29% and 16%, respectively.

The pound has been falling sharply in the past year…

 

Sterling has fallen sharply in the past year, down by 20% on the trade-weighted index. The fall against the dollar and the euro has been as deep or deeper, with depreciation of 29% and 16%, respectively. What is going on and how low can sterling go against the dollar and the euro, and what would be the implication for price inflation and hence for monetary policy? In the past, sterling declines of this order would lead to rising price inflation (see chart a) and a subsequent rise in interest rates that would weaken the economy and so help to keep inflation in check, but the Bank of England’s view is that inflation will remain low this time. The reasons are that the economy is in recession, making it very difficult for price rises to be passed on by firms (though this may mean profits fall and so unemployment ends up being higher), commodity prices are now falling after rising to record highs in mid 2008 and, crucially, wage inflation is receding, as unemployment rises and employment prospects dim.

 

 

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