What is an exchange rate?
For example, recently the US Federal Reserve has been raising rates from a low base and now has them in a range of 1% to 1.25%. In the UK on the other hand, the Bank of England cut its rate from 0.5% to 0.25% after the Referendum result in 2016 and it has stayed there since. Naturally this has weakened the pound against the dollar as the earlier chart clearly shows. Decisions about whether to create additional electronic liquidity (“QE”, which will weaken a currency) or do the reverse and remove it from the system (“QT”, which would tend to strengthen a currency) also play their part in determining exchange rates. But, whilst crucial, interest rates and any associated monetary stimulus are not the whole picture.
Current account balance
Public spending and debt
Currencies such as sterling act as a bellwether for the overall economic prospects of the UK – after all, the currency markets are the biggest and most heavily traded in the world. The Brexit vote and the recent close Election result have undoubtedly served to weaken sterling and will in all likelihood continue to do so while negotiations proceed. However, bear in mind that, as the earlier chart shows, Sterling has been weakening for some time and investors would be wise to fully understand the other reasons for this to get the full picture.
If you would like to find out more about this, or our Currency Service, please contact your Investment Manager.