The Fall of the British Pound

Michail Spanos, student of Economics, AUTH.

The British pound has been one of the strongest currencies in the exchange rate space for over decades. This happened because of British Governments that have over time ensured a credibility with which central banks exchange currency.

In short, it is the management of interest rates by the Central Bank (Bank of England) that establishes this credibility. In order to attract new investors and maintain the strength of the currency, the Bank is required to cope with various crises that may change the course of the exchange rate.

During this period, the currency has recorded one of the biggest falls in terms of its exchange with the dollar. Specifically, in the month of September, the exchange rate reached 1.033 per dollar, which determines the biggest fall of the currency over time.

But why is this happening in England?

The beginning of the decline is recorded in the period of the upward trend in energy prices.

On this occasion, the economy of the United Kingdom faced an external crisis with which there were increases in indicators concerning both the development of the country and the exchange rate of sterling.

The most dramatic of these increases were found:

• in Cost of living
• in the consumer price index – scale increase of 10%
• and the cost of imported goods.

Cost of living articulates the monthly costs that the average citizen spends, including basic goods such as housing, food, energy and others. In Britain, considering that it imports 46% of its total food per year, this indicator is highly correlated with the country’s imports. So with the high cost of energy, the continued rise in inflation and the increase in the consumer price index, sterling is experiencing a depreciation in terms of its parity with other currencies.

Accordingly, the current account balance, which includes the trade balance and net income from foreign investments and transfers, recorded a deficit of 33.8 billion, which, combined with the cost of imported energy, led to the fall of pound.

What led to the currency’s fall?

One of the most important events that led to the fall of the currency was that of the mini-budget policy followed by the former prime minister of England, Liz Truss. This policy involved a program of tax cuts in various sectors of the economy with the aim of increasing investment and the subsequent recovery of the country from the energy crisis and inflation. Despite extensive reforms, this policy package did not outline the government’s official budget that provided for the refinancing of the government deficit. So many politicians, economists and investors turned towards the depreciation of sterling on the grounds that the current policy will endanger its future course. The result of this, was to record the biggest fall of the currency in history.  

What is the future of the currency?

Based on what has happened in recent months, it is a fact that the credibility of sterling is unstable both for investors and for the global market. Several banks, such as Deutsche Bank, issue reports in which they estimate large fluctuations for the course of the currency, even formulating the possibility of a crisis.

It is a fact that much criticism has been leveled at the Bank of England for the management of the currency rate. The Bank had already lent enough funds to the government in order to ensure the credibility of investors and also to reduce interest rates on public debt. The Bank’s aim, therefore, in the upcoming months is expected to be to buy bonds until the respective government can manage its borrowing costs.

Regarding the government, the recent resignation of Liz Truss signals a new order of things for the course of the currency. With the announcement of the new Prime Minister of England, Rishi Sunak, many reforms are foreseen in which issues such as:

• High energy prices and the country’s position in Russia’s war with Ukraine
• Trade and supply chain issues to address the high Cost of Living
• Upgrading and increasing productivity to ensure parity
• And finally the restructuring of the Mini-Budget policy on 17 November

Based on all these, related announcements and forecasts it is obvious that the stability of the currency exchange rate is not a positive thing. England, like the European Union, is facing major challenges that many investors have already started to speculate about, correspondingly depreciating the British pound.

What therefore remains is how the British Government will manage all these reforms in order to restore the strength of the currency to the market and also to prevent the country from the possibility of a recession.

References:

Exchange rates: Why has the value of the pound jumped? (2019). BBC News. [online] 17 Oct. Available at: https://www.bbc.com/news/business-49179234.

‌ Cohen, P. (2022). Pound’s Swoon Echoes Declines in British Power, Past and Present. The New York Times. [online] 28 Sep. Available at: https://www.nytimes.com/2022/09/28/business/economy/uk-pound-history.html.

‌Washington Post. (2022). The British pound just plummeted: What it means for the U.K., tourists. [online] Available at: https://www.washingtonpost.com/world/2022/09/27/british-pound-drop-dollar-us-impact/

‌Fidelity UK. (n.d.). Why is the pound so strong? [online] Available at: https://www.fidelity.co.uk/markets-insights/markets/uk/why-pound-so-strong/.

‌Smith, E. (n.d.). Deutsche Bank says risk of a ‘sterling crisis’ is rising as Truss becomes UK prime minister. [online] CNBC. Available at: https://www.cnbc.com/2022/09/05/uk-deutsche-bank-says-risk-of-a-sterling-crisis-is-rising-as-truss-becomes-pm.html

[Accessed 6 Nov. 2022].

Τhe Guardian. (2022). What is the Bank of England doing in bid to stabilise UK economy? [online] Available at: https://www.theguardian.com/business/2022/sep/28/what-bank-of-england-doing-pound-dollar-uk-economy-interest-rates-bonds.

The Economist. (n.d.). How bad will Britain’s recession be? [online] Available at:

https://www.economist.com/graphic-detail/2022/11/03/how-bad-will-britains-recession-be.  [Accessed 6 Nov. 2022].