The drop in sterling is a make-or-break moment for May’s government

The ranks of the Tory party used to be heaving with City types, but not any more. Stockbrokers and bankers are regarded as politically embarrassing. One of the consequences of this is the party has lost its market nous.

If it still had that nous it would understand that, with sterling down 8 cents against the dollar in a week to a level unseen for a generation or more, Theresa May and her Government have effectively presided over the equivalent of a profits warning.

Let me explain. If you work for a large company, few things are less enjoyable. A profits warning happens when a company is doing much worse than the market realises; it finally has to disclose, and the shares dive.

What so frequently transforms a profits warning from a cock-up into a disaster – resulting in the chief executive being ejected – is not the fact the company has suffered a setback, but how it has been handled. If the management lets the share price sail on upwards when things are not, in reality, going well; and they then blurt out the truth in an unco-ordinated fashion, market trust can be destroyed. It is difficult to recover.
That is effectively what has happened to the British Government in the last week. A wildly excessive optimism about Brexit has been clumsily deflated. There have been several aggravating factors:

– An unedifying cacophony of anti-business and anti-foreigner rhetoric at the Tory party conference, raising fears that Britain may be turning its back on globalisation and embracing a “Closed Brexit” as opposed to “an Open Brexit”.

– Leaking of Cabinet papers showing that British economic growth will supposedly collapse after Brexit, taking tax revenues down with it.

– Loose talk and contradictory messages from the Treasury, No10 and ministers in Brexit departments.

– Unhelpful comments from business leaders, painting a false picture of a supposedly harmless “soft Brexit” preferable to the “hard Brexit” being sought by the Government.

– A surprise promise by the Prime Minister to initiate the Article 50 EU exit clause by March next year, while not giving any sense of what this might mean in practice and if or how Britain might regain its full status at the World Trade Organisation should things go awry.

– Ministers thinking aloud that quantitative easing will be ended and replaced by a government spending spree.

– Speculation in Tory circles that the Governor of the Bank of England, Mark Carney, will be fired or is going to resign.

People keep saying that the devaluation of sterling after the ERM crisis in 1992 led to a rebound in the British economy. Now, as then, exporters are benefitting. But on that occasion interest rates fell dramatically. This time around, the threat of inflation has already caused market interest rates to rise and the Bank of England could follow suit.

So what should be done to stop weak pound turning into a disaster?

The first thing is to do no harm. Civil servants, SPADS and ministers who believe it is their job to leak and brief against each other need to put a sock in it. More critically, Theresa May needs to drop her bizarrely anti-business rhetoric. Immediately. Needless own goals such as the terrible idea to force companies to put workers on boards should stop being scored.

In the Autumn statement next month Philip Hammond should set some anchors so markets know what to expect. A new fiscal framework, with targets for the deficit, spending and investment needs to be put in place.
Mark Carney should be confirmed as staying in place as Governor of the Bank of England. To lose this Canadian appointee now would send a terrible signal to the world. For his part, Mr Carney ought to show some contrition over his overt support for the Remain campaign in the referendum and use the next meeting of the monetary policy committee to indicate that there will be no more interest rate cuts and his latest QE money printing and bond buying programme brought to a steady halt.
The government also needs to give investors confidence that there will be more process and thought to Brexit in the short term; and, in the long term, it has an economic plan. It might consider appointing two Commissions: one to collate ideas and expertise for Brexit; and another to promote economic growth and reform.

As for the rest of us, we must brace ourselves for the risk of inflation, especially higher petrol prices and thus higher interest rates. There is something nostalgic about Theresa May, but I hope a 1970s re-run is not what she had in mind.