Tumbling pound is pouring fuel on the inflationary fire

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How hard the tumbling pound will squeeze household budget hinges on what the Bank of England will do. With the UK probably already in a recession, pulling the levers too aggressively could make the downturn worse.

Acting gently will disadvantage the pound. The Bank’s 50 basis points rate hike on Thursday saw some strengthening of sterling but far from enough to counter this year’s steady decline.

“It makes it more likely that they’ll go for faster and larger interest rate rises, because they now have this additional inflationary pressure from the pound,” said Levell.

“That would mean it’s not hardship that we would see through higher prices, it’s hardship through higher interest rates. Either way it’s not good news.”

There is no consensus on how long the pound will suffer. This will depend on factors such as the pressures from the energy crisis easing, the dollar weakening and the MPC’s approach.

Some economists – such as Prof Dennis Novy at the University of Warwick – believe currencies are too unpredictable to meaningfully forecast in the short term. “I might as well flip a coin,” he said. But he added the UK economy faces long-term challenges, which could point to a more permanent hit to the currency.

“The UK economy faces headwinds that go back many, many years. The poor productivity and the very poor economic growth go back way before the Brexit referendum. So these are long standing concerns for the British economy that seems unresolved to this day,” he said.

Most are struggling to keep up with the Federal Reserve’s “combination of strong growth and large rate hikes”, Kamakshya Trivedi of Goldman Sachs said.

He expects the pound to strengthen to 1.14 in three months and then 1.25 a year from now. He is more optimism than Dales, who believes the pound and the euro will keep falling, possibly into the middle of next year. They will then bounce back although not all the way, he said.

The uncertainty is weighing heavily on businesses that rely on imports. Fhaheen Khan, senior economist at Make UK, said the trade association was already seeing increasing enquiries from manufacturers asking what would happen to the pound.

“Because of the volatility of the exchange rate, it’s becoming significantly more difficult for suppliers and customers to agree on contracts. Some customers are asking for guarantees that if the exchange rate were to get even worse, they will still be able to benefit. The suppliers don’t want to provide that guarantee because they know that it’s so uncertain,” he said.

“This is becoming a huge issue, especially for industries with long lead times like automotive and aerospace manufacturers that tend to work on five-to-eight-year contracts.”

Over half of UK imports and exports are bought and sold to countries outside the EU. For many of these transactions, the dollar is the dominant currency.

Some 61pc of non-EU imports were bought in dollars last year, amounting to £173bn. This means that even a moderate sway in the exchange rate can send ripples through the economy.

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