The Pound’s recent plunge in context: 50 years of real interest rates

The pound’s fall over the past week has been dramatic. But even with the recovery in the currency’s value to pre-mini-budget levels, the pound has been on a downtrend in inflation-adjusted terms for the past six years.

Figure 1: PPI deflated real GBP/USD exchange rate (blue) and CPI deflated (light brown), both in logs, 1973M01 = 0. Down moves mean sterling depreciation. September PPI readings assume a continued decline with the August rate. Bloomberg Consensus for UK CPI; Cleveland Fed Nowcast for US CPI. ECRI-defined recession dates from peak to trough of recession are shaded grey. Source: Fed via FRED, BLS, ONS and own calculations.

September’s events can be viewed as the third sustained negative terms-of-trade shock the pound has experienced in the past 15 years, the first being the global financial crisis and the second being Brexit. The downward moves in the deflated real PPI rate are more notable (in my opinion) as they reflect a deterioration in the terms of trade of supposedly tradable commodities.

How do formal statistical tests relate to this claim? The deflated PPI rate rejects the unit root zero at 13% msl using the ADF test (6% for the unit root test). This means that PPP for traded goods / PPI is not very pronounced. A recursive structural break test by Bai-Perron identifies breaks around 1987, 2000 and 2015. The 2015 break comes just before the Brexit referendum.

More information about PPP etc. can be found here.

This entry was published on through Menzie Chinn.