Why is the pound falling and does it matter?

Sterling has been in apparent freefall of late, as currency traders have looked at the UK economy with increasing pessimism. Left Foot Forward explains what a falling pound means for the UK.

Following the announcement at the weekend that the UK was to lose its triple AAA credit rating, it was expected that the pound would take a pummeling on the currency markets this week.

And initially it did.

Yesterday Sterling fell against the dollar to $1.5073 – it’s lowest level since summer 2010.

As yesterday’s trading went on the pound rallied slightly to 1.16 versus the Euro.

As of lunchtime today (Tuesday 26th) £1 buys 1.1574 Euros.

But why does it matter?

A cheaper pound bodes well for exporters, who are able to target the overseas market with competitive prices. Plenty of countries with struggling economies would like nothing more than a weak exchange rate in order to export their way back to prosperity.

This is one reason why the Japanese Yen is currently being deliberately depreciated by Tokyo.

To cite an example of how a falling pound is welcomed by sections of the business community, FT economic commentator Martin Wolf greeted the news that Sterling was falling rapidly thus: “Sterling is falling. Hurrah! The economy calls for a further depreciation.”

The downside is that, as real incomes fall (and demand falls with it), even a significantly lower pound may not be sufficient to fill the export order books of British businesses. The benefits of a weaker currency may be offset by weakened demand in important export markets.

The depreciation in sterling is good news for the tourist industry, however; and it may even encourage an outflow of migrant workers from the UK, reducing the immediate pressure on unemployment numbers.

And yet the fall in Sterling will cause import prices to rise, impacting those businesses who need to import raw materials.

Ultimately, the most noticeable impact will be on working people whose take home pay has not kept pace – prices have already risen at a rate faster than incomes for the past four years, and incomes for the squeezed middle are now at the same level as they were in 2002/03.

And the cause of the drastic fall in the value of the pound?

As Larry Elliot writes in the Guardian:

“Investors have not suddenly woken up to the idea that Britain is a flat-lining economy with a twin deficit problem. They have known that for some time. The difference is that a year ago there were other more pressing things to worry about. Now there are not. That makes the pound a big sell.”

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