Understanding the Fluctuations: 20 English Pounds to Euro Since Brexit

At the beginning of 2021, the British pound (GBP) stood approximately 15% weaker against the euro (EUR) compared to its position before the 2016 Brexit referendum. This represents a significant shift in the exchange rate, impacting everything from holiday budgets to international trade. To truly grasp the implications, let’s delve into the factors driving this volatility and understand what it means when considering figures like 20 English Pounds To Euro.

The past five years have seen Brexit dominate as a key influence on the pound’s exchange rate fluctuations against major currencies. The immediate aftermath of the referendum vote witnessed the pound’s most dramatic single-day drop in three decades. Further substantial declines occurred in 2017 and 2019, pushing the pound to new lows against both the euro and the US dollar by August 2019, as illustrated in Figure 1.

This depreciation largely stemmed from growing expectations of increased trade barriers between the UK and its primary trading partner, coupled with heightened uncertainty and ongoing political instability. These factors prompted financial institutions to sell off pound-denominated assets, driving down the pound’s value relative to other currencies as demand decreased.

The Dynamics of Exchange Rate Shifts

An exchange rate is simply the price of one currency expressed in terms of another. Like any price, it is governed by the principles of supply and demand. In currency exchange, when demand for one currency within a pair increases, its value (appreciation) rises while the other currency’s value falls (depreciation).

The weakening of the pound since the referendum indicates a decrease in the demand to hold pounds compared to other currencies. To understand the underlying causes of these Brexit-related exchange rate movements, we need to identify the forces that influence currency demand.

Key Players in Exchange Rate Volatility

Businesses engaged in international trade are significant participants in currency markets. This includes companies involved in cross-border sales and individuals exchanging currency for travel. For example, when a UK business imports goods from the Eurozone, they must convert pounds into euros, increasing the demand for euros. Significant shifts in international trade patterns can therefore impact currency demand and valuation.

However, the sharp and rapid declines in the pound’s value after 2016 occurred before any actual changes in the UK-EU trading relationship. Furthermore, trade in goods and services isn’t the primary driver of overall foreign exchange transactions and doesn’t typically fluctuate dramatically in the short term Bank for International Settlements, BIS, 2019. This suggests that changes in trade are not the main cause of extreme exchange rate fluctuations, and likely not the primary reason for the Brexit-related pound depreciation.

A more critical factor behind the pound’s sharp falls since 2016 is the substantial reduction in financial institutions’ preference to hold pound-denominated investments. The trading of currencies for investment purposes, or in financial assets, constitutes the majority of currency transactions and is usually the biggest driver of exchange rate changes, particularly in the short term.

This is often referred to as ‘hot money’ – highly mobile capital that can swiftly move between investments or currencies, rapidly impacting exchange rates. Consequently, the most influential players in currency markets are financial institutions such as banks, securities firms, and institutional investors.

In 2019, financial institutions (excluding foreign exchange dealers) accounted for 57.8% of foreign exchange turnover in the UK. Direct transactions from non-financial customers represented only 4.9% of the currency exchange volume BIS, 2019.

Furthermore, the UK’s persistent trade deficit, where imports exceed exports, increases reliance on international capital inflows and makes the pound more vulnerable to global capital movements. This vulnerability arises because the current account deficit is increasingly financed by these capital inflows.

Brexit’s Impact on the Pound’s Appeal

Financial institutions operating in currency markets primarily react to factors that influence the returns on investments in different currencies. Therefore, the Brexit-related pound depreciation implies that financial market participants anticipated poorer performance from pound-denominated investments post-Brexit.

Several factors can influence returns in currency markets, and isolating individual effects is complex. However, key factors typically include changes in relative interest rates, risk perceptions, and overall investor expectations.

Interest Rate Dynamics

Changes in interest rates, or factors affecting them, are considered major drivers of exchange rates. Domestic interest rates influence the relative attractiveness of assets in different countries. Lower interest rates in a country diminish the returns on assets linked to that rate. An unexpected interest rate cut (assuming other factors remain constant) reduces demand for those assets compared to similar assets in other currencies, leading to a currency depreciation.

For instance, following the Leave vote, the Bank of England lowered interest rates in August 2016 from 0.5% to 0.25% and expanded its quantitative easing (QE) program. However, this policy change occurred weeks after the Brexit vote. Therefore, the significant pound depreciation in June 2016, or in subsequent years, cannot be solely attributed to financial market reactions to this specific interest rate adjustment.

Uncertainty and Political Instability

Changes in perceived risk also affect expected returns and influence investor decisions regarding asset holdings, including currencies. Increased uncertainty surrounding factors like future business performance, economic forecasts, interest rates, and political stability can make holding assets in a specific currency riskier, reducing or delaying investment inflows Pindyck, 1991.

The heightened likelihood of increased trade frictions between the UK and the EU post-Brexit amplified these risks for pound-denominated assets. Pre-referendum research predicted substantial declines in foreign investment in the UK due to Brexit-related trade costs Dhingra et al, 2016.

These risks were further compounded by significant and persistent political instability in the UK, prolonging and deepening uncertainty surrounding post-Brexit trade relationships and the anticipated economic outcomes. The most substantial and sustained pound depreciations since 2016 were closely linked to increased uncertainty and associated political turmoil.

One of the most significant drops in the pound’s value against the euro occurred in 2017 after an early general election resulted in a hung parliament. In 2019, the pound fell to a multi-year low against both the dollar and euro shortly after Boris Johnson became Prime Minister, fueled by concerns over a potential ‘no-deal’ Brexit – widely considered the worst-case economic scenario for the UK.

Evidence suggests that the negative consequences of this uncertainty on employment, productivity, and investment within UK businesses became increasingly apparent in the years immediately following the referendum Bloom et al, 2019.

The Power of Expectations

The pound’s depreciation occurred before Brexit actually took place. Conversely, exchange rate movements were relatively minor when the UK officially left the EU and the transition period concluded at the end of 2020. This is because investor expectations are a crucial trigger in explaining the timing of currency movements Dornbusch, 1976; Engle and West, 2005).

Changes in investor expectations are rapidly incorporated into currency markets due to the sheer volume and speed of trading. Any new information affecting currency expectations is quickly reflected in exchange rates. If market participants anticipate negative future impacts on investments in a currency, they will sell that currency, causing its value to fall.

The record pound depreciation after the referendum illustrates the rapid impact of shifting market expectations on currencies, as the Leave vote surprised many analysts. Last-minute polls suggested a Remain victory, initially causing the pound to appreciate in the days leading up to the vote. The pound’s collapse immediately after the result underscores the negative expectations financial market participants held for pound investments once the outcome became clear.

The substantial pound drops in 2017 and 2019 coincided with periods of heightened political uncertainty. These declines also reflected increasingly negative expectations for pound-denominated investments, driven by the growing probability of a ‘hard’ Brexit. Conversely, improved prospects of an orderly Brexit and a trade agreement preceded increases in the pound’s value.

Recent research has established specific links between economic policy uncertainty and exchange rate expectations Beckmann and Czudaj, 2017. Findings suggest that market participants factor in the level of policy uncertainty when forming their expectations.

Consequences of a Weaker Pound: Impact on 20 English Pounds to Euro Conversions

One immediate consequence of a weaker pound is that imported goods, services, and assets become more expensive for UK residents. This directly translates to higher inflation rates and an increased cost of living. For individuals looking to convert 20 English pounds to euro, a weaker pound means receiving fewer euros in exchange compared to periods when the pound was stronger.

For example, if before Brexit, 20 English pounds might have converted to approximately 25 euros (depending on the exchange rate), a 15% depreciation means that same 20 pounds might now only fetch around 21.25 euros. This difference, while seemingly small for a 20-pound conversion, becomes significant for larger transactions, businesses, and the overall economy.

However, a weaker currency can also offer benefits. It can enhance export competitiveness by lowering the cost of domestic goods and services for international buyers. This can potentially improve a country’s trade deficit and boost overall economic growth.

Research on the net effect of currency depreciation is inconclusive. Furthermore, ongoing uncertainty surrounding the scale and implications of post-Brexit trade frictions makes the long-term economic outcome for the UK even more uncertain. Further research is needed to fully understand the long-term consequences of the Brexit-related pound depreciation and its ongoing impact on the purchasing power of figures like 20 English pounds to euro.