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Updated 10:10 04/07/20

Why sterling is falling?

By Duncan Richardson, News Editor

07 Jun 2016

In recent weeks the pound has plummeted against most major currencies. Here’s why it happened and why sterling could be vulnerable further falls.

The value of sterling is effected by a number of factors, including inflation, growth prospects and interest rates. Developed nations tend to have stronger and more stable currencies as investors are confident to invest in those countries. When foreign companies invest in UK industry they convert their cash reserves into sterling to buy machinery, property and pay staff. This creates demand and pushes up the price of sterling when compared to other currencies.

Interest rates also impact the value of a currency. In 2015 many expected the Bank of England to flow the Federal Reserve and raise interest rates. This helped the pound stay relatively strong against most of the world’s major currencies. The economic picture in the UK has since deteriorated and investors are now reassessing their UK investments. Unsurprisingly the Bank of England has backtracked and a rate rise in the immediate future is now unlikely.

The uncertainty surrounding this month’s EU referendum is weighing heavy on the currency markets. As the likelihood of Brexit has increased so too has the volatility of the pound. A falling pound could spark a sharp rise in inflation, which could force the Bank of England to raise interest rates in attempt to protect the pound.

The recent fall is not just down to Brexit. The UK runs a significant current account deficit, which measures the difference between the amount of money flowing in and out of the economy. This deficit leaves sterling vulnerable to a possible devaluation and bears worry an unexpected shock could expose the UK’s frailty and spark a run on the pound.

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