Why is value of the pound rising? Dollar pound ratio explained, what exchange rate change means for economy
Liz Truss caused economic chaos during her time in office, before being forced to resign on 20 October
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Her tenure has seen some of the worst economic turmoil since the 1990s. Plans to introduce a swathe of unfunded tax cuts in the mini budget - most of which have now had to be scrapped - almost led to a run on pension funds, forced up the cost of public borrowing, and has pushed mortgage rates to their highest levels since the 2008 financial crisis.
Truss’s economic agenda also led the value of the pound to crumble - at one point, it hit a record low against the dollar. Unusually, the UK currency reacted positively to the PM’s announcement she would be resigning. But why exactly is the UK’s currency rising again - and what does it mean for our wallets? Here’s what you need to know.
How much has the pound fallen by?
The pound fell to a 37-year low in the immediate aftermath of the Chancellor’s mini budget. It dropped 2% against the dollar, falling below $1.10, making the dollar worth 92p.
It tumbled even lower on the Asian markets on Monday 26 September. The UK’s currency fell to just $1.03 before rallying to $1.07 when European markets opened. The IMF’s intervention 24 hours later saw the pound fall back once again to $1.06 - making the dollar worth 95p.
The weeks after the mini budget saw the pound move back to where it had been before the mini budget. It even briefly climbed above its pre-mini budget value on 4 October after the government had announced its humiliating u-turn on the 45p rate of income tax, rising to $1.15.
Despite dipping again as a result of the end of the Bank of England’s support for the pensions market and then the sacking of Kwasi Kwarteng, Liz Truss’s resignation led to a resurgence in its value. The currency leapt almost 1% in the immediate aftermath of her announcement before softening again.
All eyes will now be on who replaces Truss and what’s contained in Chancellor Jeremy Hunt’s fiscal announcement on Halloween - a plan that will come with an independent assessment of the UK’s finances from the Office for Budget Responsibility (OBR).
While the pound has rallied, it is still trading below where it was at the end of August when it was worth $1.16 - a six-year-low in itself. At the beginning of 2022, £1 was equal to $1.35. The pound has also fallen against the Euro during this turbulence. The European currency is now worth €1.13. It had been €1.19 at the end of July 2022.
Why is the pound dollar exchange rate falling?
The performance of a country’s currency is directly tied to its economic outlook. Put simply, the pound lost value because investors were not optimistic that the UK was going to get inflation under control and see economic growth with Liz Truss at the helm. The Prime Minister had been banking on the idea that economic growth will pay for her tax cuts.
Currencies lose value when confidence in them falls and fewer transactions take place - something that also means the economy is unlikely to be performing as strongly. Here in the UK, the cost of living crisis means people across the UK are cutting back on spending - something that is also bad for businesses.
While forecasts have shown inflation will peak at a much lower rate than financial institutions like Goldman Sachs had predicted - largely as a result of the energy bills support packages for household billpayers and businesses - investors feel tax cuts will keep inflation higher for longer.
They expect the Bank of England will be forced to raise interest rates further in a bid to bring inflation under control. The base rate is likely to rise again at the next meeting of the central bank’s Monetary Policy Committee (MPC) on 3 November.
UK interest rates are expected to hit at least 6% in 2023, with a growing likelihood that a percentage-point interest rate hike will be implemented by the Bank of England at its next MPC meeting. Higher interest rates means the cost of borrowing money goes up, which in turn lowers economic output as businesses feel less able to expand and invest in their operations. To make matters worse, the chances of a recession are beginning to look increasingly likely.
Another reason behind the pound’s fall against the dollar has been the strength of the US economy. As a major producer of oil and gas, it is not exposed to the same inflationary pressures Europe is exposed to as a result of its reliance on Russian energy imports. Indeed, the IMF thinks the US economy will not fall into a recession over the next year.
Why has pound risen again?
The pound rose in the immediate aftermath of Liz Truss’s resignation speech on 20 October before falling back slightly.
"We've seen the pound rally against the US dollar and euro on the back of the Truss resignation news, with the GBP rising around 1%. We've also seen long dated UK gilt yields also fall, with the benchmark 10yr yield falling around 0.2% to around 3.8%. That in itself is a strong message,” said Joshua Raymond, director at online investment platform XTB.com.
“Normally markets hate market uncertainty and the removal of a sitting Prime Minister would be taken negatively. The fact its been seen as positive tells you all you need to know about the market's attitude towards the Truss premiership.
“The markets have now seen off a complete change in leadership of both No 10 and the UK treasury in just a matter of days. That is remarkable. Investor eyes now switch firmly to who takes over as the new PM and the fact it will only take a week is helpful to remove longer term uncertainty. The focus now shifts on who takes over."
What does a fall in the pound mean?
When the pound drops in value against other currencies, the most immediate change people will notice comes when they travel abroad. Historically, the pound has been more valuable than most other major currencies. It meant that British tourists and businesses could spend less on more when making purchases on foreign soil.
But the pound almost became like-for-like with the Euro and the dollar. Given the UK is a net importer of food and fuel, a weaker pound means prices are more likely to go up - especially given the fact that oil and gas are paid for using dollars. In some cases, the rise in costs associated with the pound’s fall in value may take several months to pass onto the consumer.
Arguably the biggest problem with a weak pound is seen at government level. Kwasi Kwarteng announced tax cuts worth £43 billion, with a Treasury document estimating that these cuts and policies like the energy price guarantee would require public borrowing to rise by £72.4 billion.
The Institute for Fiscal Studies (IFS) reckons borrowing could remain as a high at £110 billion a year for several years - more than double what it was in 2019 (the last ‘normal’ year before the Covid pandemic). It said it expects taxes will have to rise and spending cuts introduced in future to pay for increasing the national debt by so much.
This borrowing will cost more money because the pound is weak, as the Bank of England is likely to raise interest rates to shore up the currency’s value. Investors have also been asking for a greater return for investing in the government bond market - the mechanism it uses to borrow money - because prices of bonds have become much lower since the mini budget.