The pound sterling has had its worst four day performance since June 2016's Brexit vote, having fallen to $1.23 and the expectations from the Bank of England are for it to fall further in the next few weeks. There has been a 19% drop since the referendum.
Brexit is clearly responsible for much of this fall. Whilst the falling pound against the dollar has actually been positive for the FTSE 100 as a large percentage of listed companies earn revenue in US dollars and are seeing an increase in their value, what is actually causing this to happen and what will the consequences be?
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| Source: http://www.bbc.com/news/business-37617813 |
Brexit is clearly responsible for much of this fall. Whilst the falling pound against the dollar has actually been positive for the FTSE 100 as a large percentage of listed companies earn revenue in US dollars and are seeing an increase in their value, what is actually causing this to happen and what will the consequences be?
How is Brexit actually causing the fall in value?
The value of the pound is seen a judgement on the future growth potential of the UK economy in comparison with the future growth potential of other currencies and economies. So this depreciation does mean that the UK is seen as having less potential growth and that is why demand for sterling may be down as investors swap to buy other currencies where growth potential is better. If realised, this expected lack of growth could become worse and lead to increased unemployment...hence the lack of demand for £s.
Also, rising interest rates can strengthen a currency. With the rate of UK interest being lowered again recently (a further lowering is not unlikely) and the US hinting at raising their rates, a further swing towards a stronger dollar was inevitable.
Plus, when a currency is moving, speculation can often exacerbate the direction. Investors might short the currency or just dump it for something a little more profitable. This is often the cause of changes in currency value and then pessimism can become a self-fulling prophecy.
What does a weak pound mean for the UK?
On a day to day basis (and in the short run) not too much will be noticed by the average person on the street, unless they're buying goods directly from overseas and a positive is that exporters may see gains as their goods appear far cheaper in foreign markets. This assumes sufficient elasticity to meet the Marshall Lerner condition and there is no real time lag.
Foreign tourism in the UK should see a boost as the pound becomes financially more attractive to swap foreign currencies for as tourists search for bargain holidays! But then UK citizens wanting to travel abroad will obviously find it more expensive as the reverse will be true.
The UK will likely see some cost push inflation as food and fuel costs rise as both are imported in large quantities. Costs will also rise for businesses who import their inputs; they will inevitably pass these costs on to their consumers. If this inflation is significant it can actually reduce the real income growth of the UK and this could be a real problem as everyone's earnings will be able to pay for less of the goods they purchase, not just from abroad but also within the UK.
Foreign tourism in the UK should see a boost as the pound becomes financially more attractive to swap foreign currencies for as tourists search for bargain holidays! But then UK citizens wanting to travel abroad will obviously find it more expensive as the reverse will be true.
The UK will likely see some cost push inflation as food and fuel costs rise as both are imported in large quantities. Costs will also rise for businesses who import their inputs; they will inevitably pass these costs on to their consumers. If this inflation is significant it can actually reduce the real income growth of the UK and this could be a real problem as everyone's earnings will be able to pay for less of the goods they purchase, not just from abroad but also within the UK.
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