Reasons behind the record low of GBP

Reasons behind the record low of GBP

Great Britain Pounds (GBP) being the currency used in the United Kingdom recorded the all-time lowest against the United States Dollar USD on 26th September 2022 resulting dollar to sterling pounds at 1.033. This has happened after a fresh 37-years British currency fell too low against the US dollar and the lowest level since the sterling pound first went into free float in 1971.

What determines the value of the currency? The value of most of the major currencies in the world is determined by the supply and demand, both domestic and foreign. Increased demand appreciates the currency value, while increased supply decreases its value. Also there are other factors that can affect currency value such as,

1. Interest Rates

Currencies of countries offering higher interest rates tend to increase in value, all else being equal. This is because fixed-income investors flock to higher interest rates, which increases the currency’s demand and value.

2. Inflation

High inflation erodes the purchasing power of the currency holder and increases the cost of local goods. Countries that are experiencing higher inflation may experience a decrease in currency demand, and therefore a depreciation in currency value.

3. Capital Flow

Capital flow represents a large portion of the demand for currency. Large amounts of capital inflow going into a country appreciate the currency, while capital outflow depreciates the currency.

4. Money Supply

Money supply refers to the money within a country at a given point in time. The higher the money supply, the lower the currency value and vice versa.

The most common way to measure currency value is by measuring its convertibility to other currencies – also known as the exchange rate. Since the end of the gold standard in 1971, the majority of the world’s currency has adopted one of two exchange rate systems which are Fixed Interest Rate and Floating Interest Rate.

Investors around the world buy and sell huge amounts of foreign currency. The aim is to profit by buying a currency that goes up in value more than the one sold. Once the GBP hit a record low in September 2022, investors rushed to dump government assets and currencies.

The pound dropped as an immediate result of the new Conservative government led by Prime Minister Liz Truss’s spending and tax plan. The record lows came in the backdrop of Chancellor Kwasi Kwarteng’s unveiling of his ambitious plan of historic tax cuts to boost economic growth.

United Kingdom tax system underwent some of the most significant changes in recent history:

  •  Elimination of the highest marginal rate of tax.
  •  Recalled the recent increases in levies for health and social care.
  •  Removed the reductions in the tax on property sales.
  •  The reversal of proposed increases to the corporation tax.
  •  Scrapped the proposed hike in alcohol taxes.

When the announcement was made that the UK would impose the largest tax cuts in 50 years, which included the removal of the 45% tax rate on incomes over 150,000 pounds ($162,000) which will largely benefit the high income markers and cancelation of the planned rise in corporation tax to 25 per cent, keeping it at 19 per cent, and reversing this April’s 1.25 percentage point rise in National Insurance contributions.

Another change included a 1 percent cut to the basic rate of income tax to 19 per cent.

Before August 2022, the UK’s consumer price index (CPI) rose by 9.9 percent in t12 months. Elevated inflation, the ongoing energy crisis in Europe and the strengthening US dollar continued to put pressure on the British pound.

Same time, political decisions made in the UK have long hurt the British pound. Political instability over forming a new government, a second Scottish independence vote, trade conflicts with the EU over the Northern Ireland protocol, Brexit. And political instability negatively impacts the GBP.

However, the recent changes in tax cuts and the PM's mini budget worried the Investors who were holding the GBP. They rushed to dump government assets and currencies as the British pound fell to its lowest value ever compared to the US dollar.

Investors were worried that the large-scale tax cuts announced by the government would bring much fiscal uncertainty and they sold the pounds as they had doubts on the government's plans.

The government was supposed to borrow an additional 72 billion pounds ($77.7 billion) over the upcoming six months to finance the tax cuts and a scheme to help consumers deal with their growing energy bills creating worries on the investors about the country's capacity to manage such a huge debt.

The dropping value of the pound, mainly due to the rising interest rates have made borrowing far more expensive. The drop of almost 5% to slightly over $1.03 occurred during trading in Forex markets in Asia and Australia. It extended a 3.6% drop from 23 September, leading to predictions the pound might fall to parity with the US currency. It managed to rebound marginally and returned to $1.07 after European traders started trading online.

The UK's economy, which has the highest inflation rate among the G7 countries, and the government's huge fiscal bet on growth are hurting the pound more than most currencies. Compared with a decline of 15% in the euro, the British pound has lost close to 21% of its value so far this year.

To tackle high inflation, the Bank of England (BoE) increased interest rates by 0.5 percentage points to 2.25 per cent, the highest since 2008. Markets are expecting monetary policies to be tightened in order to the new fiscal measures which will be not sufficient to wave off the negative effects. Therefore, markets are demanding for a higher premium for U.K. assets via a cheaper currency and lower prices on government debt.

A slump in the British pound will have profound impacts on the UK economy. Resulting more price hikes for UK consumers when importing goods. As the UK imports 50% of its food the cost of everything, from bananas to petrol, will sky rocket. Automobiles or electronics imported from other countries may become more expensive. Same time the UK has to pay a large amount on Energy and Gas as the prices for these items are largely based on the dollar. UK travelers will also suffer with the dropped pound's value as they have to pay more GBP when converting money to Foreign Currencies.

According to Samuel Tombs from Pantheon Macroeconomics, the falling pound could increase the cost of living by 0.5 percent next year. In addition, if the ongoing conflict between the Ukraine and Russia escalates, both the Pound and Euro will experience a significant fall.

Hope the blog explained the reasons which led to the record low of GBP, thanks for reading and to know about our sri lanka exchange rate and other countries exchange rates visit our home page and choose the country and enter the amount you wish to transfer. Our in-built calculator will show the exchange rate along with our remittance fees.