Currency depreciation is a loss in the value of a currency relative to one or more reference currencies, typically in a floating rate regime due to market forces. Currency depreciation occurs for various reasons including economic fundamentals, political instability, interest rate differentials and risk aversion from investors.
For example, the USD/GBP exchange rate shows the cost of one Pound in United States Dollar (USD) terms. Therefore, a rate of 1.5563 (20/07/2015) USD/GBP means that it costs 1.5563 USD to buy 1 Pound. Year on year the rate has depreciated by 15.16 percent to 1.3203 (20/07/2016), which means 1 Pound now cost 1.3203 USD. That is to say an investor pays less USD now to purchase 1 pound than one year ago. In other words the pound has depreciated against the dollar.
Impact on households and businesses within Britain
A depreciation of the Pound against the dollar, which Britain is currently experiencing post Brexit, impacts both households and businesses. For instance, a depreciation of the pound means an investor pays less USD to purchase 1 Pound. Therefore, the opposite is also true – it will now require more pounds to buy 1 USD (US dollar has appreciated/increased in value).
Consequently, a weaker pound means reduced purchasing power for British citizens travelling to foreign countries or purchasing foreign goods. Similarly for businesses a weaker pound means that they will pay more for goods bought in foreign currencies. Notably, a depreciation of the pound means that imports are becoming more expensive and exports are becoming cheaper.
The impact on the British economy would depend on a myriad of other factors including, the trade balance and the elasticity of demand of imports and exports. The British economy is at risk in light of the fact that Britain’s level of exports has been in decline over the years; and the country has experienced persistent and worsening current account deficits (the value of goods and services imported exceeds the value of goods and services exported) since the fourth quarter of 1998.
Opportunity
The depreciation in the pound does not spell bad news for all investors. For example, wealthy investors have taken the opportunity to purchase prime London real estate at current depressed prices. Additionally, US dollar earning companies also benefit from a weaker pound as the relative appreciation of the USD means a higher bottom line.
By Jade De Labastide (MSc., BSc.)
JDL Business
JDL BUSINESS 