Was the pound overvalued before the EU referendum?

17 October 2016
What was claimed

The IMF said the pound was overvalued before the EU referendum.

Our verdict

This is correct. Before the EU referendum, the IMF said that the pound was overvalued in 2015.

What was claimed

The pound is now undervalued, based on the IMF’s recommendations in February and June 2016.

Our verdict

This is uncertain. When IMF said the pound was overvalued, they based their recommendations on the assumption that the UK would vote to remain in the EU. It's open to debate what value the pound should be at now that we've voted to leave.

It’s correct that the IMF has said that in 2015 the pound was overvalued. But it’s open to debate whether it’s undervalued right now.

Having an exchange rate that’s too high can be a problem. In particular, it makes it cheap to import foreign goods (which are priced in cheap foreign currencies) and hard to sell exports (which are priced in expensive sterling). A country may end up buying much more than it sells abroad, as the UK does.

In February, the International Monetary Fund said the sterling was overvalued by somewhere between 5% and 15% in 2015. Just before the referendum, the IMF put the over-valuation slightly higher, saying that sterling was overvalued by between 5% and 20% in 2015. Other experts, like the former governor of the Bank of England and the IMF, have agreed that sterling was overvalued.

On 14 October, the effective exchange rate was 18% below the average for 2015. That’s the value of sterling compared to a range of other currencies used by the UK’s most important trading partners. If nothing had changed since the IMF’s recommendations were made, it could mean sterling was now undervalued.

But other things have changed.

When the IMF made these judgements it assumed the UK would vote to remain in the EU. In the IMF’s view, the value of the pound might need to be even lower now that the UK has voted to leave.  

That’s because leaving the EU single market would mean other countries would put tariffs (taxes) on imports from the UK. Higher tariffs would make imports from the UK more expensive and so other countries would be less inclined to buy them. To make up for this, the value of sterling would have to fall even further to keep the price of UK exports low.

So right now it’s hard to say whether the value of the pound has dropped lower than what the IMF would recommend. Since no-one knows what kind of trade relationships the UK will have once it leaves the EU, opinions on the UK’s long-term potential for trade or the best exchange rate for sterling are open to debate.

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