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British Pound drops against US Dollar to six-week low

The value of one Great British Pound has dropped to a six-week low against the US dollar and a two-week low against the Euro.


This is a decrease from February’s three year high where the pound was boosted by optimism in economic recovery.


Since the signing of the EU-UK Trade and Cooperation Agreement, a free trade agreement designed to loosen trading restrictions between the UK and EU to promote business activity, the Pound has had an increasing correlation with global factors.


This means the Sterling will usually rise when stock markets rally as investors become more bullish, at the same time, the pound is likely to fall when stock markets decline.


Paul Dales, a Chief UK Economist at Capital Economics states that “the correlation between the FTSE 100 and the pound has risen sharply since the start of 2020.”


Hence, with the confidence of European investors dropping due to the rising COVID-19 cases across Europe as well as the controversy surrounding the AstraZeneca vaccine, European economies will see a slower vaccine rollout as well as diminishing public health.


Because of this, European investors have seen a decrease in confidence as it is unlikely European economies will be able to recover as quickly as anticipated, causing the equity markets to fall.


Therefore, due to the pounds increasing synchronisation with stock markets, the pound has declined against the Euro with the exchange rate going below 1.16 and potentially at a weekly low of 1.1566.


At the same time, the Pound-to-Dollar exchange rate fell to a six-week low of $1.37.


A weaker pound will cause imports to become more expensive. This is because the buying power of economic agents is essentially decreased in foreign countries due to the devalued pound.


Because of this, imports will decrease as the unfavourable exchange rate will force economic agents such as businesses to cut back on their factor inputs as the price of foreign goods has essentially increased, causing an increase in operating costs, thus rationing the market.


This will alleviate the current account deficit which is currently at 3.8% of Real GDP according to data provided by trading economics, as there will be fewer imports, therefore, the net trade will be favoured towards exports, however, it is unlikely the weakening pound will solve the deficit.

One benefit of a weakening pound is that exports increase, this is because goods and services within the UK become cheaper for foreigners, increasing demand for UK products.


But, due to the UK being a developed economy, it has used the majority of its easily-accessible raw materials, so, the only factor input which is plentiful is labour.


Because of this, the UK specialises in providing services such as tourism, finance, medicine etc. Before coronavirus, the tourist industry contributed £106bn to the UK economy both directly as well as indirectly.


Tourism also supports an additional 2.6 million jobs. Looking at direct impacts only, tourism still contributes £48 billion, supporting 1.4 million jobs.


This makes tourism a sizeable export of the UK economy, however, due to the lockdown restrictions imposed in countries across the globe as well as a reduction in consumer confidence, the UK tourist industry has seen a large decrease in demand.


This means the benefits which the industry would receive from a weakening pound will not be felt as there is no demand for tourism in the first place. This is not a massive problem for the UK economy as it is likely this reduction is only temporary as once the majority of the global population are vaccinated, many economies will begin to open up.


Furthermore, the drop in the value of the British Pound is likely temporary. Due to the current fast vaccine rollout, economic agents will likely see an increase in confidence.


As a result of this, the UK economy is on track to reopening, once this occurs, the UK and European stock exchanges will likely rise. Hence, due to the pounds close correlation to these equity markets, the pound will too rise.


But, the retesting of 1.5 million doses of a batch from AstraZeneca will likely slow the UK’s economic recovery, additionally, the potential blockade of vaccine shipments from Europe to the UK has also been a cause of concern for the UK economy.


However, an analyst from Citibank the Pound's devaluation against the Dollar and Euro are likely to be a short-term phenomenon, and, analysts from Danske Bank state that the pound is on its way to outperform the euro area this year, supporting their view for a higher Pound-to-Euro exchange rate in 2021.

 

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