The journey of the British pound sterling against the euro has been significantly shaped by the tides of Brexit. As we stepped into 2021, the pound found itself roughly 15% weaker compared to the euro than it stood on the brink of the UK’s pivotal EU referendum in June 2016. This wasn’t an isolated dip; sterling also reflected a 20% downturn from its value when the EU Referendum Act was enacted in December 2015. These figures paint a clear picture of the economic shifts following the UK’s decision to leave the European Union, making the British Sterling To Euro exchange rate a key indicator of Brexit’s financial repercussions.
Brexit’s Volatile Footprint on the Pound to Euro Rate
Over the past half-decade, Brexit has emerged as a dominant force influencing the volatility of exchange rates, particularly the value of the pound against major global currencies. The immediate aftermath of the referendum vote vividly illustrated this impact, as sterling plummeted, marking its most dramatic single-day fall in three decades. This initial shockwave was followed by further substantial and sustained declines in 2017 and 2019. These subsequent drops pushed the value of sterling to unprecedented lows against both the euro and the dollar by August 2019, as visually represented in Figure 1.
This depreciation was largely fueled by growing expectations of increased trade barriers between the UK and its largest trading partner, the EU. Coupled with escalating uncertainty and persistent political instability, these factors prompted financial institutions to divest from the pound. As organizations increasingly sold off assets denominated in sterling, the pound’s value naturally decreased relative to other currencies, profoundly affecting the british sterling to euro exchange rate.
Understanding Exchange Rate Dynamics: Supply and Demand
An exchange rate, at its core, is simply the price of one currency expressed in terms of another. Like any market price, it fluctuates based on the fundamental principles of supply and demand. In the context of currency exchange, when demand for one currency in a pair increases while demand for the other decreases, the former will appreciate in value, and the latter will depreciate.
The post-referendum decline in sterling’s value fundamentally indicates a reduced demand for holding pounds relative to other currencies, particularly the euro. To grasp the underlying reasons behind these Brexit-related exchange rate movements, we need to explore the factors that drive the demand for a currency and influence the british sterling to euro rate.
Key Players in Exchange Rate Shifts
Organizations engaged in international trade of goods and services are significant participants in currency markets. This includes multinational corporations involved in cross-border sales and individual travelers exchanging currencies for personal expenditures. For instance, when a UK entity purchases goods from the United States, they must convert pounds into dollars, thereby increasing the demand for dollars and impacting exchange rates. Large-scale shifts in international trade patterns can thus alter the demand for, and consequently the value of, a currency.
However, the rapid and significant depreciation of sterling after 2016 preceded any actual changes in the trading relationship between the UK and the EU. Furthermore, while trade in goods and services is important, it’s not the primary driver of overall foreign exchange transactions, nor does it typically exhibit sharp short-term fluctuations, according to the Bank for International Settlements (BIS). This suggests that shifts in goods and services trade may not be the primary cause of the extreme exchange rate volatility and may not fully explain the Brexit-induced fall in the value of sterling, especially in the british sterling to euro market.
A more critical factor contributing to the sharp declines in the pound’s value since 2016 is the substantial decrease in the preference of financial institutions to hold investments denominated in pounds. Trading currencies for investment purposes, or trading in financial assets, constitutes the largest segment of currency transactions and is generally the most significant driver of exchange rate movements, particularly in the short term.
This capital, often termed ‘hot money,’ is highly mobile and can swiftly move between investments or currencies on a large scale, rapidly influencing exchange rates, including the crucial british sterling to euro parity. 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. In contrast, only 4.9% of currency exchange volume was directly attributed to non-financial customers, as reported by BIS.
Moreover, the UK’s persistent trade deficit, where imports exceed exports, increases its reliance on international capital inflows. This dependence makes the pound more susceptible to the movements of international capital and fluctuations in the british sterling to euro rate, as the current account deficit is increasingly financed by these capital inflows.
Brexit’s Impact on Pound Sterling’s Appeal
The primary factors that influence financial institutions’ decisions in currency markets are those affecting the return on investments in different currencies. Consequently, the Brexit-related fall in sterling’s value suggests that financial market participants anticipated that investments in pound-denominated assets would perform less favorably after the Brexit vote than they would have otherwise. This anticipation directly affected the british sterling to euro exchange rate.
Several factors can potentially influence returns in currency markets, and isolating their individual effects is complex. However, some of the most significant factors typically include shifts in relative interest rates, changes in perceived risk, and evolving investor expectations.
Interest Rates and Currency Valuation
Changes in interest rates, or factors influencing them, are considered primary drivers of exchange rates, including the british sterling to euro rate. Domestic interest rates can impact the relative return on assets in different countries. A reduction in a country’s interest rates diminishes the returns on assets linked to that rate. An unexpected decrease in interest rates, assuming other factors remain constant, will lead to reduced demand for those assets relative to equivalent assets in other currencies. This, in turn, causes a depreciation in the value of the currency in question.
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, it is important to note that this policy change was announced weeks after the Brexit vote. Therefore, the substantial fall in the pound’s value in June 2016, or in subsequent years, cannot be solely attributed to financial market participants’ reaction to this specific interest rate policy change, although broader interest rate expectations can play a role in the british sterling to euro dynamic.
Uncertainty and Political Instability: Risk Factors
Changes in perceived risk also significantly impact expected returns and influence investors’ decisions regarding asset holdings, including currencies. Increased uncertainty surrounding factors like future company performance, economic forecasts, interest rates, and political stability can elevate the risk associated with holding assets in a specific currency. This increased risk can reduce or delay investment inflows, negatively impacting the currency’s value, especially in the british sterling to euro exchange market.
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 had predicted substantial declines in foreign investment in the UK due to Brexit-related trade costs.
These risks were further compounded by significant and persistent political instability in the UK. This prolonged and deepened the uncertainty surrounding post-Brexit trading relationships and the anticipated economic outcomes. The most substantial and sustained declines in the pound’s value since 2016 were closely linked to increased uncertainty and associated political turmoil, directly affecting the british sterling to euro rate.
One of the most significant drops in sterling’s value 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 did not rule out a 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 in UK businesses became increasingly apparent in the years immediately following the referendum, further impacting investor sentiment and the british sterling to euro exchange rate.
The Power of Expectations in Currency Markets
The significant depreciation of sterling occurred before Brexit actually materialized. Conversely, exchange rate movements were relatively muted when the UK officially left the EU and the transition period ended in late 2020. This timing discrepancy underscores the critical role of investor expectations in triggering currency movements.
Changes in investor expectations are rapidly incorporated into currency markets due to the sheer volume and speed of trading. Any new information that alters expectations regarding a currency will swiftly be reflected in exchange rates, particularly the british sterling to euro rate. If market participants anticipate a negative future impact on investments in a currency, they will sell that currency, causing its value to fall.
The record fall of the pound after the referendum vividly illustrates the rapid impact of shifting market expectations on currencies. The Leave vote surprised many, as last-minute polls suggested a Remain victory, initially causing sterling to appreciate slightly in the days leading up to the referendum. The subsequent collapse in the pound’s value immediately after the result underscores the negative expectations that financial market participants developed for sterling investments once the outcome became clear.
The substantial falls in the pound in 2017 and 2019, during periods of heightened political uncertainty, also reflect increasingly negative expectations for sterling-denominated investments. These negative expectations were driven by the growing likelihood of a ‘hard’ Brexit. Conversely, increased optimism about an orderly Brexit and a trade deal preceded appreciations in the pound’s value against the euro and other currencies.
Recent research has demonstrated specific links between economic policy uncertainty and exchange rate expectations. Findings indicate that market participants consider the level of policy uncertainty when forming their expectations about currency values, including the british sterling to euro exchange rate.
Consequences of a Weaker Sterling
One immediate consequence of a weaker sterling is that foreign goods, services, and assets become more expensive for UK residents. This leads to increased inflation and a higher cost of living, impacting consumers directly.
However, a weaker currency can also offer benefits by making exports more competitive. By reducing the cost of domestic goods and services for residents of other countries, a weaker pound can potentially improve a country’s trade deficit and stimulate aggregate 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 complicates predictions for the UK. Understanding the long-term consequences of the Brexit-related fall in sterling, particularly its impact on the british sterling to euro exchange rate and the broader economy, requires further research and analysis.
Further Reading and Expert Insights
To delve deeper into this topic, consider exploring resources from reputable financial institutions and economic research bodies.
For expert perspectives on exchange rate dynamics and the impact of Brexit, you can consult the work of:
- 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)
These experts offer valuable insights into the complex factors influencing the british sterling to euro exchange rate and the broader implications of Brexit on currency markets.
