A fall in the value of the pound impacts a wide range of people, not simply big businesses and professional investors.
A weaker exchange rate means that the man on the street will feel the pinch too, maybe when filling up at the petrol pump or facing the extra cost of holidaying abroad this year – but who decides rate changes and how is the value determined?
How and when is the value of a currency calculated?
Money experts and economists in the media are seemingly obsessed by how the pound is faring and talk almost daily about whether it is rising or falling, and by how much.
To put it in simple terms, any movement up or down means the exchange rate of the pound against another currency or currencies has changed.
As a result, and depending which way it has moved, the pound in your pocket will now buy more or less of a foreign currency than it did before.
Because of the sheer size of the American economy, it’s common for UK economists to compare the value of the pound against the US dollar. Equally, because we trade extensively with the European Union you’ll often hear exchange rate comparisons with the Euro too.
These are the two most common rate comparisons, but it’s possible to weigh up the value of the Great British Pound or GBP as it’s often abbreviated, against any currency across the globe.
Exchange rates aren’t simply updated just once a day, they are constantly changing second by second, depending on how much demand there is for a specific country’s currency across the world.
How has the value of the pound fared in recent times?
The value of the pound has been under pressure and become weaker in recent years, predominantly due to political reasons.
Prior to Britain voting to exit the European Union in June 2016 the pound was worth just shy of 1.50 US dollars, but the ongoing political and economic uncertainty surrounding the extended Brexit negotiations has seen the value of sterling drift lower.
By the time Boris Johnson took the reigns as prime minister some three years later (July 2019), its value was almost one fifth lower at 1.22 US dollars per pound.
In early September, following MPs successfully voting to pass legislation to halt the chance of a no-deal Brexit, the pound dipped below 1.20 US dollars – its lowest value compared with the greenback for more than three years.
What factors affect the pound’s exchange rate?
The overarching reason that the pound’s exchange rate fluctuates is due to the supply and demand for sterling. If demand for the pound increases its exchange rate value goes up and vice versa.
The supply and demand isn’t down to a single cause but can be attributed to a number of separate reasons;
- If the price of goods is cheaper in the UK than in countries overseas it becomes more attractive due to it offering better value.
- Because of this increased attractiveness, businesses will purchase extra sterling so they can buy more of our cheaper goods – this higher demand will, in turn have a positive impact on our exchange rate.
- Similarly, when the Bank of England raises interest rates, it becomes more attractive to hold savings in British pounds – this leads to increased demand for our currency and increases the exchange rate.
- If the economy of the UK is strong other counties will purchase sterling as they will want to invest here – again, the exchange rate benefits from this additional purchasing of sterling.
- Movement in exchange rates is also caused by currency speculators trying to make profits by second guessing which way exchange rates will move in the future based on certain events.
How does the exchange rate affect me?
Everyday Investors across the world trade huge amounts of foreign currency and the rate at which they swap currencies gets reflected in the rate consumers get at home in the UK when they go to their bank or local foreign exchange counters.
Most of us don’t pay much attention to exchange rates until it hits us where it hurts i.e. in the pocket!
If the value of the pound decreases it means that imported goods cost more, so you’ll see an increase in your weekly supermarket food bill.
Alternatively, maybe you’re aware that oil is priced in US dollars and if the pound gets weaker it means the price you pay to fill your tank goes up too.
If you’re about to go on holiday you will probably check the exchange rate and be surprised or disappointed by how many dollars or euros you will get for your pound this year.
If you’re going abroad when is it best time to order your currency?
It’s tricky trying to predict the future value of sterling, but some money experts suggest buying half of your currency a few months ahead and the remainder a week or so before you go – it’s not a sure fire winner but it can help even out volatility of rate movements.