The Effects Of A Weakening Pound

The value of the pound dropped sharply after the EU referendum, and has been fluctuating since. It affects everyone. From holidaymakers and those filling up their cars with petrol, to business owners and investors.So why is the value of the pound changing and who decides its value? Moolr took a look, and examined the effects of a weakening pound.

How is currency valued?

When people talk about the pound falling or rising, or being strong or weak, that means it will buy more or less of a foreign currency because the exchange rate has altered. Commonly, the pound is compared to the US dollar, given the huge size of the American economy. For those going on holiday, their only comparison will be with the currency in their holiday destination. The euro is of course a common currency for comparison.

Today, many countries use what is called a floating exchange rate. With this system, the value depends on how much people want a certain currency at a particular point in time. Exchange rates change constantly. They reflect the constantly changing demand for every currency worldwide.

What has happened to the pound?

Sterling hit its lowest level in 2 and a half years at $1.2101 against the dollar in July 2019. In a similar vein, the currency’s value also fell against the euro, reaching €1.0881 at its nadir. For comparison, sterling was trading at just below $1.50 against the dollar before Britain voted to leave the EU in June 2016.

The value of sterling has continued to fall, as the government insists the UK is prepared to leave the EU without a deal. If a deal can be arranged for an exit, expect the pound to rally. A no-deal exit will only worsen the situation.

What affects the exchange rate?

Supply and demand for sterling determines the exchange rate of the pound.If demand for sterling goes up, then its price will too.

There are many factors involved here, which include the following:

  • Economy: Strong economies have strong currencies because other countries want to invest in that economy. They need the local currency to do so, pushing up demand and the money’s worth
  • Savings: When UK banks raise interest rates,  savings or investments in pounds becomes more attractive. This is because you get more back for your money. A consequence of this is that the demand for sterling increases
  • Prices: If UK goods are cheaper than those abroad, they will become more attractive to foreign businesses. These businesses need sterling to purchase them. This will usually raise the exchange rate.
  • Public finances: The state of a government’s bank balance can also affect the exchange rate
  • Speculation: The exchange rate is highly vulnerable to currency speculators, who buy and sell sterling based on expectations of future events. A lot of people have made money this way since the result of the EU referendum.

Much of the daily fluctuation in the exchange rate is because of these actions of the speculators and their confidence in the country’s economic prospects. Or lack of confidence.

Holidays

The obvious consequence of a weak pound has been felt by all of us who have holidayed or travelled abroad in recent times. Quite simply, you get less bang for your buck. You get lower amounts of foreign currency, so even if the destination has not seen any inflation, you will have less money to spend.