It’s been a chaotic few weeks for the British economy as financial turmoil and uncertainty grip the nation.
In the wake of a disruptive mini-budget from Liz Truss’ new government, the British pound took a nose dive to a record low of $1.035 against the US dollar. Although it seems to have stabilised in recent days, it remains at low levels versus many other currencies.
What does this all mean? Has it ever happened before and if so how bad? Let’s find out.
What is the pound sterling?
The pound sterling is the oldest existing currency in the world and the official national currency of the UK, as well as a few other associated territories.
What does it mean if the pound sterling has crashed?
The value of the pound sterling is determined by the demand for it in the financial markets. If it has crashed it means fewer people wish to buy it and so its relative value against other currencies has gone down. It becomes weaker.
What does a weak pound mean?
If the pound is weak, it means your money won’t stretch as far when you pay for goods and services imported from overseas, such as oil and food. It also means if you travel to other countries, especially the US, things like meals out and accommodation will cost you a great deal more. Even the cost of the plane ticket might increase due to rises in fuel prices.
As for businesses, importing from abroad becomes more expensive. It also means government borrowing costs increase.
On the plus side, a weak pound might be good for UK tourism, as foreign travellers seek to come to the country to take advantage of the increase in their spending power.
Why is the pound so weak?
A multitude of factors has driven the value of the pound down in 2022. Soaring energy prices as well as Putin’s war in Ukraine have caused inflation rates in the UK to rise, which has subsequently increased fears that the country's economy will soon drop into a recession.
The recent mini-budget has also done little to restore global confidence in the pound as many believe the planned tax cuts, extra government borrowing and increases in public spending, will cause further pressure on prices.
When has the pound significantly dropped before in history?
Here are five examples from the past half century when the pound has taken a turn for the worst on the financial markets:
1967 Devaluation
In 1964, Labour came to power led by Harold Wilson. The new government inherited an economy in real peril and faced a deficit of £800 million. Wilson was opposed to cutting the value of the pound sterling – a move that would help elevate the situation - as he believed the pound was a vital symbol of national status.
Various monetary packages introduced by the government kept devaluation at bay until pressures inevitably became too much. In 1967, Wilson’s government begrudgingly yielded and devalued the pound from $2.80 to $2.40. Informing the nation, Wilson famously declared that ‘the pound in your pocket’ was worth no less after devaluation; a controversial comment seemingly ignoring the facts.
1976 IMF Crisis
In 1975, UK inflation was nearly at 25% driven by hefty government spending in the early 70s. Combined with an oil crisis, a balance of payments deficit and a public spending deficit, the country was facing a financial crisis.
With the pound in free-fall, slipping below $2 for the first time in history, the Labour government under James Callaghan applied to the International Monetary Fund (IMF) for a loan of $3.9 billion. It was the largest loan ever taken out from the IMF at that point in history, a severe knock to Britain’s prestige as a major economic power.
To secure the loan, the UK had to agree on deep cuts in public expenditure, a move that greatly affected future economic and social policy.
1985 Strong Dollar
Before the current slump, 1985 saw the lowest pound valuation against the US dollar, sliding to $1.05. For the first time in history, parity with the dollar was a real possibility.
This slump, however, was less due to pound weakness and more to do with dollar strength. In the early 80s, the dollar saw vast appreciation as President Ronald Reagan instituted a series of tax cuts and spending rises.
Several major economies across the globe felt the squeeze of the strong dollar. To combat the situation, the world's richest nations (which included the US) agreed to cooperate to bring down the value of the dollar. It was an unprecedented agreement that was known as the Plaza Acord and between 1985 and 1987 the dollar fell by around 40%.
1992 Black Wednesday
In the build-up to the introduction of the Euro, the European Exchange Rate Mechanism (ERM) was created. Its goal was to stabilise economies, as countries wishing to switch to the incoming Euro had to keep the value of their currency within a specific range for several years.
The UK joined the ERM in 1990 but after two years the pound was beginning to depreciate and coming close to the lower limits set by the ERM. John Major’s Tory government took action to prevent the pound from slipping further but all was in vain. On 16 September 1992, the UK was forced to withdraw from the ERM after breaching those limits, causing the pound to plummet even further.
The day became known as Black Wednesday, helping Labour achieve a landslide victory in the 1997 general election after destroying the Conservative’s economic credibility. However, in the long run, Black Wednesday kept the sterling out of the Eurozone and saved it from more serious economic problems down the line.
2016 Brexit
The British people voted to leave the European Union (EU) after a referendum was held in June 2016. The subsequent departure of the UK from the EU became known as Brexit. In the immediate aftermath of the vote, the pound slumped dramatically, reaching a low point of $1.145 in October 2016.
Although the pound recovered in the coming months and years, it has yet to reach pre-Brexit levels.
