UK: Weaker Sterling means slower consumer spending – Goldman Sachs

Andrew Benito, Research Analyst at Goldman Sachs, suggests that the main macro implication of Brexit is that Sterling import prices need to rise relative to export prices.

Key Quotes

“As the UK leaves the EU, access to key export markets will decline as the cost of international trade rises somewhat. The relative price of tradeable goods (and services) will also need to rise relative to non-tradeables. A weaker nominal level for Sterling anticipates and reflects those changes in the UK’s equilibrium real exchange rate. The rise in CPI inflation to 2.3%, and above the BoE’s 2.0%yoy target, reflects this process having begun.”  

“While a weaker currency helps usher in required adjustments to Brexit – including by supporting exports, and this effect applies even before the UK has negotiated the form of Brexit – it also reflects a new regime with lower real incomes than otherwise. We expect real consumer spending to slow to reflect that.”

“The consumer has, so far, been slow to show any sensitivity to a squeeze in real income growth. In this Daily, we explain why we expect consumer spending to slow this year and why we expect the BoE to ‘look through’ an inflation overshoot associated with that.”

“How the BoE responds across 3 Acts of real exchange rate shifts...

We expect the BoE to ‘look through’ a temporary overshoot of the inflation target that owes to a required adjustment in relative prices – as it has in the past, even if the reason for the latest shift in the real exchange rate is different.”

“Our central case is that the BoE raises rates in 2019Q2 and not before. Above all, that view requires consumer spending to slow and some slack to open up to encourage the BoE to ‘look through’ an inflation overshoot that is part of the UK’s required adjustment to Brexit.”