The pound’s exchange rate versus other major currencies in the financial market has dropped considerably since the Brexit vote in 2016. As a result, it appears that it reflects a generally pessimistic view of the UK’s economic future without the EU not only from the member countries but also among overseas investors.
At the beginning of 2021, the pound was 15% lower against the euro, also lower than it was in December 2015, when the EU Referendum Act gained Royal Assent. The Brexit vote or Brexit deal has also been one of the primary factors that caused the changes in the exchange rate and the value of the pound sterling against the other major currencies. The impact of Brexit was most visible immediately following the referendum vote with sterling falling to its lowest level in 30 years in a single day.
All those primarily due to the financial institutions selling the pound in anticipation of greater trader frictions between the UK and its major trading partners, as well as heightened uncertainty and ongoing political instability. The value of the pound fell in relation to other currencies as more companies sold assets that were denominated in sterling.
Changes in the Exchange Rate
The price of one currency in relation to another is known as the exchange rate. The factors that define it are supply and demand. At its most basic level, the decline in sterling’s value after the vote indicates a decrease in demand for holding the currency against other currencies. To comprehend the underlying lessons, it is important to firstly, identify the variable that influences currency demand.
Currency markets are well-known as essential participants for organizations interested in international trading of commodities and services. The event had an especially major impact on the foreing exchange market and the Forex trading brokers in the United Kingdom were put in a very difficult situation since it also caused the increase in the transaction fees. Especially, the companies that are providing goods and services outside the country, as well as the travelers who are changing money for personal purposes, fall into this category as well. When a UK citizen or firm buys products in the US, it is required for them to convert pounds into dollars. It means that the dollar’s relative demand is rising. As a result, large shifts in international commerce of goods and services can affect currency demand and value.
However, the quick and significant decline in the value took place in 2016 before the actual changes between the relations of the EU and the UK took place. Furthermore, trade-in products and services are not the main sources of total foreign exchange transactions, and it does not tend to fluctuate dramatically in the near term.
The significant drop in financial institution’s propensity for holding investments denominated in pounds since 2016 is a key driver of the pound’s rapid depreciation. The trading of currencies for investment reasons or the trade of financial assets accounts for the majority of currency transactions and is usually the most important driver of exchange rate fluctuations, especially in emerging markets.
Why did the Pound Become Less Attractive?
The major factors that impact the return on investments are ones that financial institutions respond to in currency markets. As a result, a drop in the value of the pound linked to Brexit implies that those who are involved in the financial market felt that the investments that are denominated in pounds would perform worse after the Brexit decision was finalized.
A lot of aspects can influence currency market results and it is difficult to separate the various influences. Nonetheless, changes that occur in interest rates, risks, and expectations are among the most important elements.
Interest rate changes are viewed as the major driver of currency rates. This is because the relative return on assets in various nations is affected by local interest rates. When a country’s interest rate is cut, assets that are linked to that rate earn less money. In comparison to analogous assets, an unexpected drop in interest rates will cause a drop in demand for such assets.
Changes in risk can have an impact on projected returns and investors’ asset allocation decisions. Increased uncertainty about future corporate performance, the economic interest rates, and political stability can all increase the risk of keeping assets in a given currency, decreasing or delaying investment flows.
These risks were magnified for assets denominated in pounds due to the significant possibility of increased trade frictions between the UK and the EU following Brexit. Before the referendum, research indicated that Brexit-related trade costs would cause significant drops in foreing investments in the UK. These dangers were exacerbated by the UK’s ongoing political unrest, which lasted and heightened uncertainty about post-Brexit commercial ties and the anticipated economic consequences. Increased uncertainty and attendant political upheaval were strongly linked to the most significant and continuous decline in the pound since 2016.
The decrease in the value of the pound occurred before the Brexit vote. When it was officially voted that the transition period concluded in 2020, during that time exchange rate fluctuations were quite small. This is because investor expectations are a key factor in determining when currency moves take place. Due to the enormous volume and pace of transactions, changing investor expectations are swiftly integrated into currency markets. Exchange rates will swiftly reflect any fresh information that alters assumptions about the currency itself.