The journey of the British Pound (GBP) against the Euro (EUR) since the 2016 Brexit referendum has been marked by significant volatility and a persistent weakening of Sterling. By the beginning of 2021, the pound was approximately 15% weaker against the euro compared to its position before the referendum vote, and a substantial 20% weaker than when the EU Referendum Act was enacted in December 2015. This dramatic shift underscores the profound influence of Brexit on the Gbp Pound To Euro exchange rate.
Over the past half-decade, Brexit has emerged as a dominant factor shaping exchange rate fluctuations and the value of the pound relative to major global currencies. The immediate aftermath of the referendum witnessed Sterling’s most significant single-day drop in three decades. This initial shock was followed by further substantial and sustained declines in 2017 and 2019, culminating in the pound reaching new lows against both the euro and the dollar in August 2019, as illustrated in Figure 1.
Figure 1: Daily fluctuations in the GBP to EUR exchange rate from 2015 to 2021, highlighting the impact of Brexit.
This depreciation was largely attributed to growing expectations of increased trade barriers between the UK and the European Union, its largest trading partner. Coupled with heightened uncertainty and ongoing political instability, these factors led financial institutions to reduce their holdings of pound-denominated assets. As institutions divested from Sterling, the GBP Pound to Euro exchange rate, along with other currency pairings, was inevitably driven downwards.
Understanding Exchange Rate Dynamics: Supply and Demand
An exchange rate represents the price of one currency in relation to another. Like any market price, it is governed by the fundamental principles of supply and demand. In the context of currency exchange, an increase in demand for a particular currency leads to its appreciation, while a decrease in demand results in depreciation. Therefore, to comprehend the underlying drivers of Brexit-related movements in the GBP Pound to Euro exchange rate, it’s crucial to identify the factors that influence the demand for a currency.
In essence, the weakening of the pound since the referendum signifies a decline in the global demand to hold Sterling compared to other currencies, especially the Euro.
Key Players in the Currency Market: Beyond Trade
Businesses engaged in international trade are significant participants in currency markets. When UK entities import goods from Eurozone countries, they need to convert pounds into euros, thereby increasing the demand for euros and impacting the GBP Pound to Euro rate. Similarly, tourism and personal currency exchange contribute to these flows.
However, the rapid and substantial drops in the value of Sterling following the 2016 referendum occurred before any tangible changes in the UK-EU trading relationship were implemented. Moreover, trade in goods and services isn’t the primary driver of foreign exchange transactions, and it typically doesn’t fluctuate dramatically in the short term. This suggests that while trade plays a role, it may not be the main catalyst behind the extreme volatility observed in the GBP Pound to Euro exchange rate and the overall depreciation of Sterling linked to Brexit.
The dominant force behind the sharp falls in the pound’s value since 2016 is the significant reduction 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 share of currency transactions and is generally the most significant driver of exchange rate movements, particularly in the short run.
This type of capital flow is often referred to as ‘hot money’ – highly mobile capital that can swiftly move between investments or currencies on a large scale, rapidly influencing exchange rates. Consequently, the most influential players in currency markets are financial institutions, including banks, securities firms, and institutional investors.
Data from 2019 reveals that financial institutions (excluding foreign exchange dealers) accounted for 57.8% of foreign exchange turnover in the UK, while non-financial customers were directly responsible for only 4.9% of currency exchange volume. This highlights the disproportionate influence of financial investment decisions on currency values, including the GBP Pound to Euro exchange rate.
Furthermore, the UK’s persistent trade deficit, where imports consistently exceed exports, increases its reliance on external financing and makes the pound more susceptible to international capital movements. This current account deficit has been increasingly funded by these capital inflows, making the GBP Pound to Euro exchange rate more vulnerable to shifts in investor sentiment.
Brexit’s Negative Impact on Sterling’s Appeal
Financial institutions, as key drivers in currency markets, respond primarily to factors that influence the returns on investments in different currencies. The post-Brexit decline in the GBP Pound to Euro exchange rate and Sterling’s overall value indicates that financial market participants anticipated poorer performance from pound-denominated investments following the referendum outcome.
Several factors can affect returns in currency markets, and isolating the individual effects can be complex. However, some of the most influential factors are typically shifts in relative interest rates, changes in perceived risk, and evolving investor expectations.
Interest Rate Adjustments and Currency Value
Changes in interest rates are widely recognized as a primary determinant of exchange rates. Domestic interest rates can impact the relative attractiveness of assets in different countries. Lower interest rates in a country reduce the returns on assets linked to that rate. An unexpected interest rate cut, holding other factors constant, typically leads to decreased demand for those assets relative to assets in currencies with higher interest rates. This, in turn, causes a depreciation of the currency in question, affecting pairings like the GBP Pound to Euro exchange rate.
For example, 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 occurred weeks after the Brexit vote. Therefore, the immediate and substantial fall in the GBP Pound to Euro exchange rate and Sterling’s value in June 2016 and subsequent years cannot be solely attributed to the financial market’s reaction to this specific interest rate adjustment.
Uncertainty and Political Instability: Amplifying Risk
Changes in risk perception significantly influence expected returns and, consequently, investor decisions regarding asset holdings, including currencies. Increased uncertainty surrounding factors like future business performance, economic forecasts, interest rate trajectories, and political stability can elevate the perceived risk of holding assets in a specific currency. This heightened risk can deter or delay investment inflows, impacting the GBP Pound to Euro exchange rate.
The increased likelihood of trade frictions between the UK and the EU post-Brexit amplified these risks for pound-denominated assets. Pre-referendum research projected 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, which prolonged and deepened uncertainty regarding post-Brexit trade relationships and the likely economic consequences. The most pronounced and sustained declines in the pound since 2016 were closely correlated with heightened uncertainty and associated political turbulence, directly affecting the GBP Pound to Euro exchange rate.
For instance, 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. Similarly, in 2019, the pound plummeted to a new multi-year low against both the dollar and the euro shortly after Boris Johnson became Prime Minister and signaled a willingness to consider a ‘no-deal’ Brexit – widely considered the most damaging economic scenario for the UK. These political events directly impacted investor confidence and the GBP Pound to Euro exchange rate.
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.
The Power of Expectations in Currency Markets
Crucially, the depreciation of Sterling largely preceded the actual implementation of Brexit. In contrast, exchange rate movements were relatively subdued when the UK formally left the EU and the transition period concluded at the end of 2020. This highlights the critical role of investor expectations in driving currency movements, including the GBP Pound to Euro exchange rate.
Changes in investor expectations are rapidly incorporated into currency markets due to the immense volume and speed of trading. Any new information that influences expectations about a currency’s future prospects is quickly reflected in exchange rates. If market participants anticipate a negative future impact on investments in a particular currency, they will sell that currency, causing its value to fall, influencing the GBP Pound to Euro rate.
The record fall in the pound immediately after the referendum exemplifies the swift impact of shifting market expectations on currencies. Last-minute polls suggested a Remain victory, which initially caused Sterling to appreciate in the days leading up to the vote. The subsequent collapse in the pound’s value immediately following the Leave result underscores the negative expectations financial market participants held for Sterling investments once the outcome became clear and directly impacted the GBP Pound to Euro exchange rate.
Similarly, the significant falls in the pound in 2017 and 2019, impacting the GBP Pound to Euro rate, occurred during periods of heightened political uncertainty and reflected increasingly pessimistic expectations for Sterling-denominated investments due to 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 against the euro.
Recent research has established specific links between economic policy uncertainty and exchange rate expectations, further emphasizing the role of anticipated future conditions in determining the GBP Pound to Euro exchange rate.
Consequences of a Weaker Pound: Inflation and Competitiveness
One immediate consequence of a weaker pound, impacting the GBP Pound to Euro exchange rate and other pairings, is that imported goods, services, and assets become more expensive for UK residents. This directly contributes to higher inflation rates and an increased cost of living.
However, a weaker currency can also offer potential benefits. It can enhance export competitiveness by reducing the cost of domestic goods and services for buyers in other countries, including the Eurozone. This can potentially improve a country’s trade deficit and stimulate overall economic growth. The impact of a weaker GBP Pound to Euro exchange rate on UK exports is a complex issue with varied opinions on its overall effectiveness.
Research on the net effect of currency depreciation is mixed. Furthermore, ongoing uncertainty surrounding the extent and implications of post-Brexit trade frictions complicates predictions for the UK economy. Understanding the long-term consequences of the Brexit-related depreciation of Sterling and its impact on the GBP Pound to Euro exchange rate requires further in-depth analysis.
Further Reading and Expert Insights
For deeper exploration of this topic, consider researching the work of 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)
These experts offer valuable perspectives on exchange rate dynamics and the economic impacts of Brexit.
Author: Christopher Coyle
Image: Euro and Pound coins symbolizing the GBP to EUR exchange rate.
