The US currently has the biggest economy in the world. The UK comes in at number five after China, Japan, and Germany. So if the US economy is so huge, why does the pound to dollar ratio consistently value the Great British Pound more than the mighty US dollar? Let’s take a look.
How much stronger is the pound than the dollar?
At the time of writing, £1 is worth around $1.38. In fact, throughout history, the pound to dollar ratio has broadly been in favour of the pound.
At one of its highest points back in the early 1970s, a single pound was worth more than $2. Its lowest came in 1985 when the pound was valued at just $1.07. The pound has never fallen below this since.
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So, why does the pound to dollar ratio show a stronger GBP?
There are a number of reasons why one currency is worth more than another. This includes things like history, politics, national economic policy and a host of other factors such as supply, demand and productivity. Let’s take a look at three of the more general reasons for the greater pound to dollar ratio.
Inflation measures the value of money. If there’s high inflation, prices rise, which means the cash in your pocket doesn’t go as far.
It’s the same principle on a national scale. A country with a high inflation rate will see the price of its goods rise, which makes exports less affordable and attractive to other countries. On the flip side, countries with lower inflation rates can remain competitive.
Ideally, central banks like to keep inflation as steady as possible. The Bank of England, for example, likes to keep levels at around 2%. As a country, our inflation rate is currently 2.1%, whereas in the US it’s more than double at 5%.
2. Speculation and sentiment
Speculation is essentially what investors and economic forecasters do – taking a punt on the economy.
A huge range of factors will influence the decisions people make. But if they think the economy is likely to take an upturn and invest, that increases the currency’s overall desirability and strengthens its position.
Sentiment is similar to speculation, but it’s more to do with general opinions such as how stable the country is or whether the government can be trusted to pay its bills.
The UK has traditionally always been held in high regard as stable and trustworthy, even Brexit wasn’t enough to keep the GBP down for long. With that in mind, it’s no surprise that the value of the USD has been particularly volatile amidst the internal conflict the US is experiencing.
3. Balance of payment
This balance of payment (BOP) is a record of all the financial transactions one country has with the rest of the world. Think of it as a current account that lists your income and outgoings.
With your current account, if your outgoings are more than your income, you’ll be overdrawn. With a BOP, if the value of a country’s outgoings (what is spent on imports) is bigger than its income (what it earns from exports), it’s called a deficit.
The US has the world’s largest BOP deficit, currently at $195 billion (around £141 billion). In contrast, the UK’s deficit is £12.8 billion which is considerably less.
A country’s BOP by itself doesn’t shape the value of its currency but does influence it. After all, if you continue to buy more stuff without selling anything to pay for it, where is the money coming from?
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How does the pound to dollar value affect me?
The value of the pound affects us in various ways that we probably don’t even think about. If the pound is strong, it’s cheaper to buy things from other countries. That in itself can be a conundrum – as cheap imports can mean a reduction in local production, which can change and shape manufacturing and, ultimately, employment.
Of course, the biggest effect will be when you buy foreign currency. So, if you were planning on travelling to the US, your GBP would ‘buy’ you more dollars. In other words, your money will go further.
Differences in monetary value also attract foreign exchange investors who buy and sell currencies, but it can be an extremely volatile market.
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