The rate of exchange between the British pound and the world’s other major currencies has recently been a topic of discussion among forex traders. Despite the Bank of England raising interest rates, there has been no noticeable improvement in the value of the pound. We will look at some of the reasons that may have led to the emergence of this phenomenon in the following paragraphs.

Introduction

The Bank of England raised interest rates from 0.25% to 0.50% in November 2023, the first increase in more than three years. It was expected that this move would raise the value of the pound since higher interest rates attract investors from other nations. Regrettably, the value of the pound did not rise as much as expected. Because of the present situation, many forex traders are wondering why the pound isn’t strengthening despite rising interest rates.

Inflation

One of the key reasons why the value of the pound has not grown as much as expected is inflation. Inflation is defined as the rate at which the prices of goods and services continue to grow over time. When inflation is high, a country’s currency loses purchasing power, causing the currency’s value to fall. Despite the increase in interest rates, the UK’s inflation rate remained high in November 2023, at over 3.2%.

But it takes time for rising interest rates to reduce inflationary pressures. Inflation has the ability to erode the advantages of higher interest rates in a relatively short period of time. Moreover, rising interest rates may raise the cost of borrowing money, which may lead to a decrease in consumer spending and a slowdown in economic growth.

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Uncertainty surrounding Brexit

The uncertainty produced by Brexit has had an impact on both the UK economy and the value of the pound. The United Kingdom’s choice to leave the European Union has resulted in a decrease in both commerce and investment, resulting in a decrease in demand for the pound. Investors find it difficult to forecast the long-term prospects of the UK economy because of the uncertainty surrounding the UK’s future trade links, which has also made it difficult for investors.

Since the Brexit vote in 2016, the value of the pound has been very volatile, and this volatility has maintained in the years thereafter. The value of the pound plummeted quickly after the referendum, and it has been difficult to return to pre-referendum levels. Even when interest rates are hiked, the pound struggles to rise because investors lack confidence in the UK economy as a consequence of Brexit uncertainty. This makes the pound’s climb harder.

Political uncertainty

The degree of political instability may also affect the value of a currency. Several changes in government have occurred in the United Kingdom in recent years, and continuous disagreements about the country’s future have contributed to the country’s volatile political atmosphere. As a consequence of this uncertainty, investors are having a more difficult time projecting the UK economy’s future prospects, which has resulted in a drop in demand for the pound.

The United Kingdom’s relationship with the European Union has been a major source of political instability in recent years.  Brexit has presented both negative and positive possibilities, and consequently, there is currently uncertainty about the future direction of the United Kingdom’s economy. Even though interest rates have been boosted, the pound has struggled to gain owing to the political uncertainty posed by Brexit.

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The trade imbalance

When a country buys more goods and services than it sells overseas, it creates a trade imbalance. The United Kingdom has experienced a trade imbalance for many years, indicating that it has imported more products than it has exported. This deficit may cause a drop in demand for the currency, which may cause a drop in demand for the pound, putting pressure on the pound’s value. The current account deficit may make it more difficult for the UK to finance its trade deficit, putting more pressure on the pound’s value.

It has proven difficult to find a solution to the long-standing problem of the United Kingdom’s trade deficit. The imbalance is generated in part by the UK’s reliance on imported goods, but it is also driven by the fact that certain industries are not as competitive as they might be. The pound has been under pressure as a result of the trade deficit, making it harder for the currency to rise even when interest rates are hiked. Despite the fact that interest rates have been raised, this is still the case.

The global economic situation

The value of a currency is determined not just by elements impacting that country’s economy but also by economic events in other nations. The global market’s economic conditions may impact both the demand for and the supply of a currency. In recent years, global economic conditions have been uncertain, with a number of countries enduring economic challenges.

For example, the Federal Reserve of the United States has been raising interest rates, causing the value of the US dollar to increase. The rising value of the US dollar has put pressure on other currencies, notably the British pound. Notwithstanding the fact that interest rates have been lifted, the pound has struggled to make meaningful gains due to global economic conditions.

The central bank’s policy

Central banks’ monetary policies are another element that may impact the value of a currency. The value of the pound was expected to rise as a direct consequence of the Bank of England’s decision to raise interest rates, but the bank’s policies on other problems, such as quantitative easing, may also have an impact on the currency’s value.

The increase of an economy’s money supply may be done via the employment of quantitative easing, a monetary policy instrument utilised by central banks. The value of the currency may fall as a consequence of the greater availability brought about by this technique. Even if interest rates are hiked, the value of the pound may struggle to rise because of the Bank of England’s quantitative easing program, which was previously employed to support the economy. This approach may have an impact on the pound’s value by making it more difficult for the currency to appreciate.

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Conclusion

Notwithstanding the Bank of England’s decision to raise interest rates, the value of the pound has not grown. This might be attributed to a variety of factors. The value of the pound has been influenced by a number of factors, including inflation, the unpredictability of the Brexit vote’s result, political volatility, the scale of the trade deficit, the present status of the global economy, and the central bank’s policies.

Forex traders must have a strong grasp of the basic aspects that determine the value of a currency before making any trading decisions. To understand how a currency’s value is decided, it is critical to go beyond interest rates and investigate other aspects that may influence its worth.

The fact that the value of the pound did not rise despite an increase in interest rates emphasises the need for diversifying one’s investment portfolio. Forex traders could consider trading in other currencies and assets as a hedge against the volatility of currency values. Diversification may help mitigate the hazards of forex trading and provide a more consistent return on investment. Diversification may also help boost the chance of profit.

Furthermore, the fact that the pound’s value did not rise despite an increase in interest rates shows the complexities of the foreign currency market. In addition to interest rates, forex traders must consider a variety of factors when evaluating the value of a currency. They should not rely just on interest rates.