The reason the Pound fell after the BoE raised interest rates

in busy •  5 months ago

The Bank of England raised interest rates today, going from 0.5% to 0.75%, but the pound unexpectedly fell afterwards.

So what's the explanation? The first thing to understand is that the currency doesn't just move because of speculators and forex traders. It moves because real money is moving into and out of the country.

As you can see from the graph, the pound initially rose on the news that interest rates rose, and some people then took advantage of that movement to sell. But who?

My guess is that all the hot money that surged into the pound from 2012 onwards, thanks to the eurozone crisis and other goings on, are now exiting as No Deal Brexit looms.

Ashoka Mody, the ex-IMF economist wrote an interesting article in October 2016, after the referendum, called The Unwinding of the pound carry trade. Here is what he had to say:

Starting in 2012, once the financial crisis had been left well behind and fiscal austerity had been eased, a renewed property-buying frenzy started in London and neighbouring regions, as Figure 1 shows. Believing that property prices would continue to rise, even Russian oligarchs and Indian billionaires thought the craziness was a safe investment. The speculative capital inflows caused the pound to appreciate. The exchange rate became overvalued, which hurt exports and drove up the current account deficit.

The 'carry trade' worked through property prices and the exchange rate feeding off each other. As London house prices appreciated, the expectation formed that prices would keep appreciating. After increasing about 6% in 2012, London house prices rose by between 12% and 15% a year for the next three years. The expectation that price increases would continue attracted speculative foreign capital, which bid up the value of the pound. Foreign speculators stood to gain twice, from both rising property prices and an appreciating pound. Presumably, they understood that the party could not go on forever. But, as in speculative bubbles, each investor believed that he or she could reverse the trades before the collapse began.

... All asset prices fell sharply after the referendum vote for Brexit on 23 June 2016... The weakness of the pound was strikingly correlated with similar weakness of property-related asset prices (the FTSE property index and the Real Estate Investment Trust (REIT) index). Just as the pound remained well below its pre-Brexit levels, so did prospects for property values.

The hot money that had parked itself in what the London Mayor called "gold bricks" started to exit once the shock Leave result became clear. The first money out was money invested in property funds. But real property has been sold in the last two years too - London is the only part of the UK where property prices are dropping especially at the top end.

As it has become clear over the summer that a No Deal Brexit is looming and that Theresa May may not last as Prime Minister, more foreigners have sought to remove their money from the UK. Estate agents report that there has been a surge in properties listed for sale, but no accompanying surge in buyers.

The number of properties listed in July 2018 increased by 8.6%. Some of these are from former buy-to-let landlords. But a lot will be foreign speculators who bought flats in London hoping for capital appreciation, and are now selling in anticipation of a rough Brexit.

Received wisdom is that the pound will fall on 29th March 2019 if there is No Deal Brexit. But of course it will be obvious long before that if No Deal is on the cards. And if you are a foreigner with money tied up in property, you need to sell now and then take your money out of the country before the expected selling of the pound occurs.

That's why the sell off in the pound occured today. As it rose to $1.312, a whole lot of sellers pounced to try to exit at that rate and tanked the market. We're going to see a lot more of this as Brexit Day approaches.

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This is quite insightful. I'm a newbie in macroeconomics and finance, so articles like these are really helpful as case study materials for learning. Thanks! Hope to see more quality articles from you