Falling exchange rates: the impact of Brexit on the British pound and the British economy
Depreciation:
● After the Brexit vote in June 2016, the British pound fell by about 15% against the US dollar
and euro.
● GBP to US$ dropped from $1.48 to $1.29 soon after the referendum. By October 2016 it hit a
low in over 3 decades of $1.20.
Causes of depreciation:
● Lower investor confidence due to expectations of increased trade frictions between the UK
and its largest trade partners.
● Increased uncertainty and political instability led financial institutions to sell the GBP.
○ DIAGRAM: rightward shift in supply. Organisations sold sterling-dominated assets.
Effect on the BoP:
Current account balance: Lower current account deficit, improved trade balance:
● Increased exports due to price competitiveness.
● Decreased imports because they became more expensive. The UK is heavily
import-dependent (current account deficit). The falling pound made imported raw materials
and consumer goods more expensive.
Interpretation of table: the current account
deficit worsened slightly in 2016 initially,
but then improved. This supports the
J-curve effect, where the BoP worsens in
the short-run after a depreciation because
contracts are fixed in the short term and
price elasticities are low initially (the
Marshall-Lerner condition is not met
initially).
“Following the Brexit referendum in 2016, the UK experienced a sharp depreciation of the pound
sterling. While this made UK exports more price competitive, the current account balance initially
worsened, moving from -5.2% of GDP in 2015 to -5.8% in 2016. This short-term deterioration can be
explained by the J-curve effect, where the values of imports rise faster than export volumes adjust.
However, by 2017, the current account deficit had improved to -3.5% of GDP, suggesting that the
Marshall-Lerner condition eventually held as export demand became more elastic over time.”
Impact on inflation
● Cost-push inflation: the weaker pound made imports more expensive, increasing input costs
for UK businesses and making imported consumer goods less affordable.
● The prices for these imports was especially spiked: energy, food and manufacturing.
, The Bank of England attributed this sharp increase in the rate of inflation primarily to the post-brexit
depreciation.
Impact on unemployment
Positive impact:
The weaker pound boosted net exports by making UK goods more competitive. This can stimulate
aggregate demand (AD), leading to increased output and lower cyclical unemployment.
● Employment during 2021 in exporting businesses rose from 9.4 million to nearly 13 million
(3.6 million employee increase) → growth.
● The number of UK exporters increased from 35,000 to 62,000 according to the Chartered
Institute of Export.
● In particular, Wales and Northern Ireland experienced the largest increases in the number of
exporters post-Brexit.
Evaluation → however, the real increase in incomes was lower due to inflation, offsetting gains in
demand.
Interpretation → this data suggests that the positive demand-side effects from exports generally
outweighed inflationary and uncertainty pressures with respect to unemployment.
● The UK labour market is flexible, so firms may have held off on wage increases rather than
cutting jobs.
Depreciation:
● After the Brexit vote in June 2016, the British pound fell by about 15% against the US dollar
and euro.
● GBP to US$ dropped from $1.48 to $1.29 soon after the referendum. By October 2016 it hit a
low in over 3 decades of $1.20.
Causes of depreciation:
● Lower investor confidence due to expectations of increased trade frictions between the UK
and its largest trade partners.
● Increased uncertainty and political instability led financial institutions to sell the GBP.
○ DIAGRAM: rightward shift in supply. Organisations sold sterling-dominated assets.
Effect on the BoP:
Current account balance: Lower current account deficit, improved trade balance:
● Increased exports due to price competitiveness.
● Decreased imports because they became more expensive. The UK is heavily
import-dependent (current account deficit). The falling pound made imported raw materials
and consumer goods more expensive.
Interpretation of table: the current account
deficit worsened slightly in 2016 initially,
but then improved. This supports the
J-curve effect, where the BoP worsens in
the short-run after a depreciation because
contracts are fixed in the short term and
price elasticities are low initially (the
Marshall-Lerner condition is not met
initially).
“Following the Brexit referendum in 2016, the UK experienced a sharp depreciation of the pound
sterling. While this made UK exports more price competitive, the current account balance initially
worsened, moving from -5.2% of GDP in 2015 to -5.8% in 2016. This short-term deterioration can be
explained by the J-curve effect, where the values of imports rise faster than export volumes adjust.
However, by 2017, the current account deficit had improved to -3.5% of GDP, suggesting that the
Marshall-Lerner condition eventually held as export demand became more elastic over time.”
Impact on inflation
● Cost-push inflation: the weaker pound made imports more expensive, increasing input costs
for UK businesses and making imported consumer goods less affordable.
● The prices for these imports was especially spiked: energy, food and manufacturing.
, The Bank of England attributed this sharp increase in the rate of inflation primarily to the post-brexit
depreciation.
Impact on unemployment
Positive impact:
The weaker pound boosted net exports by making UK goods more competitive. This can stimulate
aggregate demand (AD), leading to increased output and lower cyclical unemployment.
● Employment during 2021 in exporting businesses rose from 9.4 million to nearly 13 million
(3.6 million employee increase) → growth.
● The number of UK exporters increased from 35,000 to 62,000 according to the Chartered
Institute of Export.
● In particular, Wales and Northern Ireland experienced the largest increases in the number of
exporters post-Brexit.
Evaluation → however, the real increase in incomes was lower due to inflation, offsetting gains in
demand.
Interpretation → this data suggests that the positive demand-side effects from exports generally
outweighed inflationary and uncertainty pressures with respect to unemployment.
● The UK labour market is flexible, so firms may have held off on wage increases rather than
cutting jobs.
