Since the 2016 Brexit referendum, the English Pound To Euro Exchange Rate has become a focal point for economists, businesses, and individuals alike. The value of the pound sterling against the euro has experienced significant volatility, largely influenced by the UK’s departure from the European Union. This article delves into the key factors driving these fluctuations and what they mean for the UK economy and beyond.
The Brexit Effect on GBP/EUR Exchange Rate
Immediately following the 2016 referendum, the pound sterling saw its most dramatic single-day drop in 30 years. This initial shock was followed by further sustained declines in 2017 and 2019, pushing the pound to euro exchange rate to new lows. By the start of 2021, the pound was approximately 15% weaker against the euro compared to its pre-referendum value in June 2016, and 20% weaker than in December 2015 when the EU Referendum Act was enacted.
This depreciation was primarily driven by market anticipation of increased trade barriers between the UK and the EU, its largest trading partner. The uncertainty surrounding the future economic relationship, coupled with political instability, prompted financial institutions to reduce their holdings of pound-denominated assets. This sell-off of sterling assets naturally decreased demand for the pound, driving down its value relative to the euro and other currencies.
Exchange Rate Dynamics: Supply and Demand
At its core, an exchange rate represents the price of one currency in terms of another. Like any price, it is governed by the principles of supply and demand. When demand for a currency increases, its value appreciates; conversely, when demand decreases, its value depreciates.
In the case of the English pound to euro exchange rate, the post-referendum decline in the pound’s value indicates a reduced demand for holding sterling relative to the euro. To understand why Brexit has impacted this demand, we need to examine the key players and factors that influence currency exchange markets.
Key Players in Currency Exchange Markets
While international trade in goods and services plays a role in currency exchange, it’s not the primary driver of short-term exchange rate fluctuations. Companies engaged in import and export, along with individual travelers, participate in the currency market, but their combined volume is dwarfed by financial institutions.
Financial institutions, including banks, securities firms, and institutional investors, dominate currency markets. Their transactions, often referred to as ‘hot money,’ involve trading currencies for investment purposes and constitute the vast majority of foreign exchange turnover. In 2019, financial institutions in the UK accounted for nearly 58% of foreign exchange turnover, while non-financial customers represented less than 5%.
These institutions are highly sensitive to factors that affect the expected return on investments denominated in different currencies. Therefore, the significant shifts in the pound to euro rate post-Brexit reflect changes in the attractiveness of pound-denominated investments from the perspective of these major financial players.
Brexit’s Impact on Pound Sterling’s Attractiveness
Several interconnected factors contributed to the decline in the pound’s appeal to investors following the Brexit vote:
1. Interest Rate Adjustments
Interest rates are a primary mechanism influencing exchange rates. Lowering interest rates in a country reduces the return on assets denominated in that currency, making them less attractive to investors. Following the Leave vote, the Bank of England lowered interest rates in August 2016 from 0.5% to 0.25% and expanded quantitative easing. While this specific policy change occurred after the initial referendum shock, it signaled a potential weakening economic outlook, contributing to negative sentiment towards the pound.
2. Uncertainty and Political Instability
Increased uncertainty and political instability significantly elevate the risk associated with holding assets in a particular currency. Brexit amplified uncertainties surrounding future UK-EU trade relations, economic performance, and political stability. The prolonged and often tumultuous nature of Brexit negotiations further exacerbated these risks.
Significant drops in the pound’s value coincided with periods of heightened political uncertainty, such as the 2017 general election resulting in a hung parliament and the 2019 period when a ‘no-deal’ Brexit became a prominent possibility. These events underscored the perceived risks associated with the UK economy and the pound sterling.
3. Shifting Investor Expectations
Currency markets are forward-looking, with exchange rates heavily influenced by investor expectations. The sharp fall in the pound immediately after the referendum highlights the rapid impact of changing market expectations. The unexpected Leave vote triggered a swift reassessment of the prospects for the UK economy and, consequently, for investments denominated in pounds.
As the likelihood of a ‘hard’ Brexit increased, expectations for sterling-denominated investments became increasingly negative, leading to further declines in the pound to euro exchange rate. Conversely, positive developments, such as hopes for a smooth Brexit transition or a trade deal, have been associated with temporary increases in the pound’s value.
Consequences of a Weaker Pound
A weaker pound has both positive and negative consequences for the UK economy. On the downside, it increases the cost of imported goods, services, and assets, leading to higher inflation and a rise in the cost of living for UK residents.
However, a weaker currency can also boost export competitiveness by making UK goods and services cheaper for international buyers. This can potentially improve the UK’s trade balance and contribute to economic growth. The overall impact of a weaker pound is complex and subject to ongoing debate and research.
Further Exploration
Understanding the dynamics of the English pound to euro exchange rate requires continuous monitoring of economic and political developments in both the UK and the Eurozone. Factors such as inflation rates, interest rate decisions, economic growth figures, and political stability in both regions will continue to shape the future trajectory of this important exchange rate.
Experts in the Field:
- Mark P. Taylor (Washington University)
- Ronald MacDonald (University of Glasgow)
- Keith Pilbeam (City, University of London)
- Jeffrey Frankel (Harvard University)
- Christopher Coyle (Queen’s University Belfast)
Author: Christopher Coyle
Image Source: PublicDomainPictures from Pixabay
