Why did our currency plummet and why does it matter?

As almost everyone in the UK who’s read a paper or watched the news since the referendum results began to show ‘Brexit’ was going to win, the pound’s value fell of a cliff on Friday with the worst single day’s loss in history.

In this article I’m going to attempt to explain some of the reasons for this, where the GBP’s value is predicted to do in the coming weeks by the major banks and the actions that the Bank of England took to prevent the currency dropping even further than it did.

GBP:USD intraday chart

Why did this happen?

The drop in the currency happened for two reasons, the first is that it was unexpected and the second is the uncertainty that the UK now faces with no real plan for how an exit of the European Union will actually work.

When people talk about the markets they need to realise that the markets are people who are making the best judgements for their clients money (like our pension funds, ISA’s and investments) based on the information that they have. When the UK voted to exit the consensus of the market (and bookies) was that the UK would likely remain in the EU based on their research and based on the fact that virtually every economic expert/business around the world was clear in advising that if the UK leaves there would be serious economic implications, so the market ‘priced in’ the UK remaining part of the EU into our currency value.

When the UK voted to leave it meant many of these investors were left in a position that they were now holding investments they would not have made if they had known the UK would vote to leave, both from a currency and from a companies perspective, so they began to adjust their positions as fast as they could to keep their investors money safe which lead to a massive ‘correction’ of the value of the pound from what they thought it was worth in the EU and what is was with the UK leaving.

Isn’t this just banks/traders making money?

It’s true that whenever there is volatility in a market for any reason then there are a lot of people that make, and lose, money dependent on their positions and how they’ve traded but this shouldn’t be mistaken for the main reason the currency fell and will, according to several major banks analysis, continue to trade lower against the US Dollar (USD) for the foreseeable future.

The value of our currency is based on the strength of our economy today and it’s future prospects, or at least peoples best guess of it and as far as the outside world can see we’ve basically turned our back on one of the world’s largest single markets with no real plan as to what to do next.

But the Pound’s value went back up again didn’t it?

The value of the pound did rebound slightly before beginning to drop again towards the end of the day, this isn’t because this will just ‘blow over’ it’s because Mark Carney, the Governor of the Bank of England, made a statement committing to provide a £250 billion of additional funds which helped stabilise the panic in the market temporarily, enough money to pay for our membership of the EU for at least 25 years (over 31 at todays net rate of circa £8 billion a year).

Where will the value of the Pound go next?

There’s a split among analysts on where the currency is likely to go next, with HSBC expecting consistent drops in the currency value for the next six month to being worth $1.20 by the end of the year, which ties in with the estimations by Credite Suiss.

UBS believes the pounds value will stay in the $1.30’s whereas Societe General believes it could fall as low as $1.13-$1.15

I can’t find any bank that says the pound will increase but I’m happy to update this post if you spot someone I’ve missed.

Why does the exchange rate matter?

The U.S. dollar is the currency most used in international transactions and is the world’s primary reserve currency. It’s the currency used to buy and sell oil and it’s also used a the main currency when we import goods from many international markets outside of Europe as it’s seen as a stable currency.

This means significant changes like we’ve seen if sustained for more than a couple of weeks will mean that fuel prices will increase as will the cost of many of the things we buy, from food through to the cost of consumer goods.

Some of the prices rises will happen quicker than other as some companies will have currency reserves in place or have goods that have already been paid for. The most likely items to rise in price quickly are imported food and fuel, which will then have a smaller knock on effect to the cost of all goods as transport costs increase.

That being said in my business I’ve now had three suppliers write to me already advising that they will likely be increasing prices across the board between 5-15% unless the value of the pound increases significantly over the next week.

So what’s next?

The consensus is that the GBP is likely to, at best, stay at the same kind of level or if not fall  further over the coming months which means that we’re likely to see increases in prices of food, fuel and transport until some certainty returns to the UK.

This isn’t good news but knowing what to expect at least means you shouldn’t panic when it happens. The increase in prices on it’s own is unlikely to be catastrophic the biggest problem is if we all stop spending money just in case, which could cause a far more serious issues.

So go out there, live your life, spend money like you normally do and be prepared for prices increases.

What do you think?

This article is based on my view of the information available and an analysis of the facts and recent events. If you have a different view or think I have it wrong please share your thoughts and let me know, I’m always interested in hearing other points of view and it’s only by working together we’re going to get through the next couple of years.

Sources and further reading:
I’ve used a variety of sources from financial markets for the figures and sentiment quoted in this article but they are also mostly covered in the easiest digestible form on the BBC News website.

BBC News

Liverpool Echo

Pound Sterling Live

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