The exchange rates and how they are affected by the strength of the pound
More than likely the largest single factor that affects demand for the pound is the economic health of the United Kingdom or how the market is expecting the United Kingdom economy to fare in the future.
Sterling is what is known as a free floating currency, so its exchange rate or its price in relation to another currency is determined purely by supply and demand. Simply put, the more the pound is in demand internationally then the stronger its exchange rate will become.
Investors are likely to move finances away from weakening economies. The worsening of expectations for the UK economy in 2008 goes a long way to explain sterling’s sharp decline.
Looking at the strength of the pound and its effects on the exchange rate. A higher interest rate will mean you will get a far better return on bonds and other Government securities and therefore this in turn will tend to attract financial capital from overseas. If currency markets expect the United Kingdom base rates to fall, the pound as a knock on effect will tend to weaken.
A currency is likely to weaken in order to correct a big trade deficit, which is unsustainable in the long-run, therefore making exports cheaper and imports a lot more expensive.
One of the most immediate effects that this has on most families is an increase in the cost of travelling overseas. As a pound buys less of a foreign currency, hotels abroad, goods and services will become much costlier.
This will also mean that imported goods to the United Kingdom in turn will become more expensive to the consumers and to businesses that import raw materials or components as part of their production process. Meanwhile exporters who price their goods in sterling will benefit as their goods will become cheaper in overseas markets
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