The UK Foreign Exchange Market

Too often in the study of economics, what is learnt in the classroom bears little resemblance to reality. Thus when learning about what determines a country’s foreign exchange market, one talks  about the demand and supply of currency and how these can be affected by confidence in the currency.This week’s movements in the foreign exchange market provide an example of this.  Following the EU negotiations and the announcements by Michael Gove and Boris Johnson that they were in favour of Brexit, thereby increasing its likelihood and the probability of increased uncertainty over the next few months, there was a significant fall in the value of sterling (from £1 = $1.44 to $1.41 once the markets opened over the weekend and a further fall this week to £1 = $1.38, the lowest rate against the dollar in 7 years.

The implications of the fall in the exchange rate for the economy are significant. Exporters will gain, particularly if they import relatively few components and raw materials. However consumers, particularly if planning a foreign holiday will lose out, as will retailers who sell imports and travel companies dealing in the overseas market.

Possibly most worrying should be the impact of the increased uncertainty and fall in the value of the pound on the financial account of the UK’s balance of payments (the section dealing with such things as lending, borrowing and the sale and purchase of financial assets). We have been able to run a current account deficit because foreigners have been happy to buy UK property, government bonds, shares, etc. If these flows start to diminish and the fall in the exchange rate is not enough to significantly reduce imports and increase exports, the impact on the exchange rate could be very interesting indeed.

The £:$ xchange rate over the last week

 

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What has happened in the UK economy recently?

GDP 3rd quarter growth dropped to 0.5%, largely due to a weak construction sector.

Private sector wages are growing at their fastest rate for 13 years at approximately 3.5% in real terms in the three months to August. However this is partly due to the very low inflation we have experienced in recent months.

The unemployment rate has dropped from 5.5% to 5.4% in the three months to August, the lowest since Spring 2008 and deflation has returned with the September rate being -0.1%.

Oil demand is predicted to fall still further, suggesting prices will remain low throughout 2016 according to the International Energy Agency.