Sir Keir Starmer’s newly elected Labour government is trying to address the UK’s public sector deficit by growing the economy. However, in contrast to the brief administration of Liz Truss, he is seeking to achieve this not by cutting taxes, but by encouraging greater investment. With the UK languishing at the bottom of the G7 investment league table for 28 of the past 42 years this approach is not without merit. If — and it is a big if — he is successful in his aim of boosting growth, the potential upside to sterling appears substantial. Using more than 150 years of data, it is possible to show that, after adjusting for relative price changes, the real sterling/US dollar exchange rate is mean reverting. Measured on this basis, sterling is currently some 15% cheap relative to its average over the past 60 years or so. If investors come to believe that Labour’s plan will work then, against an uncertain political backdrop in the US and Europe, sterling could more than recover the ground lost since the Brexit vote, and rise above-long run fair value.
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