At the beginning of 2021, the British pound (GBP) was significantly weaker against the euro (EUR) compared to its position before the 2016 Brexit referendum. Specifically, the pound sterling was approximately 15% lower against the euro than it was in June 2016, just before the vote on the UK’s membership in the European Union (EU). This devaluation was even more pronounced when compared to December 2015, when the EU Referendum Act was enacted, showing a 20% decrease.
The past half-decade has seen Brexit emerge as a dominant factor influencing the volatility of exchange rates, particularly the British Pound Euro Rate. The immediate aftermath of the referendum vividly illustrated this impact. Sterling experienced its most dramatic single-day drop in three decades following the vote result. This initial shock was followed by further substantial and sustained declines in 2017 and 2019. These drops culminated in the pound reaching new lows against both the euro and the US dollar by August 2019, as illustrated in Figure 1.
Figure 1: Pound/Euro daily exchange rate 2015-2021. Source: Bloomberg.
This depreciation was largely driven by growing expectations of increased trade barriers between the UK and the EU, its largest trading partner. Coupled with heightened uncertainty and ongoing political instability, these factors prompted financial institutions to sell off pound-denominated assets. This sell-off, as more organizations divested from sterling, further weakened the pound’s value relative to other currencies, directly impacting the british pound euro rate.
Understanding Exchange Rate Dynamics and the Pound Euro Rate
An exchange rate, such as the british pound euro rate, represents the price of one currency in relation to another. These rates are not static; they fluctuate based on the fundamental principles of supply and demand. In the context of currency exchange, when demand for one currency within a pair increases while the other decreases, the former appreciates in value, and the latter depreciates.
The post-referendum decline in the value of sterling essentially indicates a reduced demand for holding pounds compared to other currencies, especially the euro. To fully grasp the underlying reasons for these Brexit-related shifts in the british pound euro rate, it’s crucial to identify the factors that influence the demand for a particular currency.
Key Players Influencing the British Pound Euro Rate
Businesses engaged in international trade are significant participants in currency markets, directly impacting rates like the british pound euro rate. This includes companies involved in cross-border sales of goods and services, as well as individual travelers exchanging currency for personal use. For instance, when a UK entity purchases goods from the United States, they must convert pounds into dollars, thereby increasing the demand for dollars in the foreign exchange market. Significant shifts in international trade volumes can therefore influence the demand and valuation of a currency, affecting pairs like the british pound euro rate.
However, the rapid and substantial depreciation of sterling following 2016 occurred before any actual changes in the trading relationship between the UK and the EU had materialized. Furthermore, trade in goods and services isn’t the primary driver of overall foreign exchange transactions and doesn’t typically exhibit sharp short-term fluctuations (Bank for International Settlements, BIS, 2019). This suggests that shifts in goods and services trade are not the primary cause of extreme exchange rate fluctuations, and might not be the main factor behind the Brexit-induced decline in sterling and the altered british pound euro rate.
A critical factor behind the sharp falls in the pound’s value since 2016 is the significant decrease in the preference of financial institutions to hold investments denominated in pounds, influencing the british pound euro rate. Currency trading for investment purposes, or trading in financial assets, constitutes the largest portion of currency transactions. It is typically the most significant driver of exchange rate movements, particularly in the short term.
This is often referred to as ‘hot money’ – capital that is highly mobile and can be rapidly shifted between investments or currencies on a large scale, causing swift changes in exchange rates and the british pound euro rate. Consequently, major participants in currency markets, influencing the british pound euro rate, 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 currency exchange volume attributable to non-financial customers was only 4.9% (BIS, 2019).
Additionally, the UK’s persistent trade deficit, where imports consistently exceed exports, increases reliance on international capital flows. This makes the pound more susceptible to the movements of international capital and hence more volatile in pairs like the british pound euro rate. The current account deficit has become increasingly dependent on these capital inflows for funding.
Brexit’s Impact on Pound Sterling’s Appeal and the British Pound Euro Rate
The primary drivers influencing financial institutions’ decisions in currency markets, and thereby the british pound euro rate, are factors affecting the returns on investments in different currencies. The post-Brexit decline in sterling’s value indicates that financial market participants anticipated that investments in pound-denominated assets would perform worse after the Brexit vote than they would have otherwise.
While numerous factors can influence returns in currency markets, making it challenging to isolate individual effects on rates like the british pound euro rate, some of the most prominent include changes in relative interest rates, shifts in risk perception, and evolving investor expectations.
Interest Rates and the Pound Euro Rate
Changes in interest rates are widely recognized as a primary driver of exchange rates, including the british pound euro rate. Domestic interest rates impact the relative returns on assets in different countries. A decrease in a country’s interest rates reduces the returns on assets linked to that rate. An unexpected interest rate cut (assuming other factors remain constant) leads to decreased demand for those assets compared to equivalent assets in other currencies, causing a depreciation of the currency in question and impacting the british pound euro rate.
For instance, in response to 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 was announced weeks after the Brexit vote. Therefore, the significant drop in the pound’s value in June 2016, and subsequent years, cannot be solely attributed to financial market reactions to this specific interest rate event, though broader interest rate expectations play a role in the british pound euro rate.
Uncertainty, Political Instability, and the Pound Euro Rate
Changes in perceived risk also significantly affect expected returns and influence investors’ decisions about asset holdings, including currencies and thus the british pound euro rate. Increased uncertainty surrounding factors like future company performance, economic outlook, interest rates, and political stability can make holding assets in a specific currency riskier. This can reduce or delay investment inflows, negatively impacting the british pound euro rate.
The heightened probability of increased trade friction 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.
These risks were compounded by significant and persistent political instability in the UK. This prolonged and deepened uncertainty surrounding post-Brexit trading relationships and the anticipated economic consequences, further pressuring the british pound euro rate. The most substantial and sustained falls in the pound since 2016 were closely linked to heightened uncertainty and associated political turmoil.
One of the most significant depreciations of sterling against the euro occurred in 2017, following an early general election that resulted in a hung parliament. In 2019, the pound fell to a new multi-year low against both the dollar and the euro shortly after Boris Johnson became Prime Minister and declined to rule out a ‘no-deal’ Brexit – widely considered the worst-case economic scenario for the UK and a key driver of the fluctuating british pound euro rate.
Evidence suggests that the negative consequences of this uncertainty for employment, productivity, and investment in UK businesses became increasingly apparent in the years immediately following the referendum.
Expectations and Currency Valuation
The depreciation of sterling largely occurred before Brexit actually took place. In contrast, exchange rate movements were relatively muted when the UK officially left the EU and the transition period concluded at the end of 2020. This highlights the importance of investor expectations as a trigger for currency movements, including the british pound euro rate.
Changes in investor expectations are rapidly incorporated into currency markets due to the sheer volume and speed of trading. Any new information that affects expectations about a currency is quickly reflected in exchange rates. If market participants anticipate a negative future impact on investments in a currency, they will sell that currency, causing it to depreciate and altering the british pound euro rate.
The record fall in the pound after the referendum demonstrates the rapid influence of changing market expectations on currencies. The Leave vote surprised many commentators, with last-minute polls suggesting a Remain victory, which initially led to sterling appreciation. The subsequent collapse in the pound’s value immediately after the result underscores the negative expectations financial market participants held for sterling investments once the outcome was clear, profoundly impacting the british pound euro rate.
The significant pound depreciations in 2017 and 2019, and their effect on the british pound euro rate, occurred during periods of heightened political uncertainty. These falls also reflected increasingly negative expectations for sterling-denominated investments driven by the growing likelihood of a ‘hard’ Brexit. Conversely, improved prospects of an orderly Brexit and a trade deal preceded increases in the pound’s value.
Recent research has established specific links between economic policy uncertainty and exchange rate expectations, further validating the role of expectations in determining exchange rates like the british pound euro rate. Findings suggest that market participants factor in the level of policy uncertainty when forming their expectations, directly impacting currency valuations.
Consequences of Sterling’s Depreciation on the British Pound Euro Rate and Beyond
One immediate consequence of a weaker pound, and a less favorable british pound euro rate, is that foreign goods, services, and assets become more expensive for UK residents. This translates to higher inflation levels and an increased cost of living.
However, a weaker currency can also offer benefits. It can enhance export competitiveness by reducing the cost of domestic goods and services for residents of other countries. This could potentially have positive effects on the country’s trade deficit and overall economic growth.
Research on the net effect of currency depreciation is mixed. Furthermore, uncertainty surrounding the scale and implications of post-Brexit trade frictions persists, making the long-term economic outcome for the UK even more ambiguous. Further research is needed to fully understand the long-term consequences of the Brexit-related depreciation of sterling and its impact on the british pound euro rate and the broader economy.
Further Reading
For those seeking deeper insights into this topic, resources from institutions like the Bank of England and the London School of Economics (LSE) provide valuable data and analysis. Monitoring financial news outlets like the Financial Times and Reuters can also offer up-to-date perspectives on currency market trends and the british pound euro 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)
