In these post-Brexit vote times, there appears to be a media obsession with the daily fluctuations in the value of the pound. Every rise is seen as a cause for economic optimism, and every fall considered a sign that things are getting worse.
Markets prices fluctuate. We need to look beyond the noise, and identity long term trends and prospects. Fortunately, markets for currency futures exist to tell us what they think will happen to the pound over the longer term.
Expect the pound to recover
Right now, a pound buys US$1.31 compared to the immediate pre-Brexit vote high of US$1.49. The markets expect this to recover slightly to US$1.38 over the next five years. Does this mean that the markets expect the UK economic outlook to improve over the next five years? Perhaps, but not necessarily so.
Some economic models (e.g. the Dornbusch model) expect exchange rates to ‘overshoot’ in response to an economic shock, before a gradual reversion to a new equilibrium even if economic fundamentals have not changed. The reasoning is that whilst currency markets can respond almost immediately, other markets (e.g. the goods or labour markets) take a longer time. As such, currency values initially ‘overshoot’ to compensate for this, before adjusting over the longer run as other parts of the economy respond.
Regardless of what the currency markets now think of uncertainty and UK economic outlook, my instinct is that with the right policies and with a long term view (think decades), Brexit Britain could be richer and wealthier than the counterfactual EU Britain.