How World Events Impact The British Pound (GBP)

Over the course of history in the United Kingdom, the pound sterling, or British pound (ISO code: GBP), has served as a conduit for international trade and as a global safe haven for investors. Although periodic war and political uncertainty have heightened the volatility facing the pound, it has stood the test of time and remains a viable facilitator of trade.

The British pound is considered to be the world's oldest living currency, with its origins traced to the specie-based "sterling" in 775AD. The "sterling" was a silver coin that served as the primary form of money in Anglo-Saxon domains, with 240 sterlings weighing exactly one pound.^[1]

The exclusive use of sterlings for trade within Great Britain continued until 1694 and the creation of the Bank of England. The Bank of England assumed the duty of printing paper banknotes that represented various denominations of sterlings and pounds. These early banknotes serve as the basis for the modern form of the British pound.

{1792-1815} Napoleonic Wars

The Napoleonic Wars pitted French military power against coalitions led by Great Britain and assorted allies for the sovereignty of Europe. The primary concern of Great Britain was preventing a seemingly unavoidable French invasion upon the homeland.

France, led militarily and politically by Napoleon Bonaparte, postured aggressively towards Britain and enjoyed military success in dominating much of the European landscape. However, Great Britain enjoyed the security of having global naval superiority, which served as a formidable challenge for potential invaders. The imminent threat of a French invasion remained until Britain's overwhelming naval victory at the Battle of Trafalgar in 1805.^[2] Although a French invasion of Britain never came to fruition, Napoleon remained a prominent figure and military threat until his demise in 1815 at the Battle of Waterloo.

The Napoleonic Wars created conditions destructive to the pound's valuation. Widespread currency counterfeiting took hold in the region, leading the Bank of England to suspend the convertibility of banknotes for gold in 1797. This era in British history is known as the "Restriction Period," because the Bank of England no longer had the ability to exchange gold for pound-denominated banknotes.

As a result, inflationary pressures took hold in the U.K. and greatly reduced the purchasing power of the pound. Widespread inflation and the pound's subsequent devaluation occurred following the printing of money for the finance of military operations against France in additional an artificial increase of the money supply through counterfeiting. Inflation during the Napoleonic Wars peaked in 1800, with the price of consumer goods increasing 36.5% over the previous year.^[4]

By 1814, 28.4 million British pound banknotes were in circulation, and only 2.2 million pounds of gold were held for exchange by the Bank of England. Accordingly, the pound experienced a 30% depreciation.^[5]

{1861-1865} United States Civil War

Known in Europe as the "American Question," the United States Civil War quickly became the focal point of contentious debate within the U.K. During this period, the nation had substantial capital investment in the U.S. and had also served as a trade partner to both the Union and Confederacy. The importation of cotton from Confederate states ensured the operation of textile mills in northern Britain and Ireland, while British banks financed industry in Union states.^[6]

As the Civil War gained momentum, pressure mounted upon the U.K. to choose a side. In response to questions regarding her country's potential role in the war, Queen Victoria issued the "Proclamation of British Neutrality" on May 13, 1861. The proclamation designated Britain as neutral and declared the Confederate party of the Southern states "belligerents."^[7] The declaration of neutrality was perceived as an "unfriendly act" by President Lincoln and the Union, due to Queen Victoria's labeling of the Confederate party as "belligerents." The label of "belligerent" meant that the Confederacy could purchase munitions and weapons from neutral countries and seize ships on the high seas. This designation strained diplomatic relations between the U.K. and the Union, because the U.K. sold weapons and ships directly to the Confederacy.^[8]

Great Britain's economy grew during the Civil War through the sale of munitions, clothing, ships and steel to both the Union and the Confederacy. Additionally, the U.K. was involved in financing war efforts on both sides, acting as the single largest holder of Civil War bonds in the world.^[9]

The economic growth realised by the U.K. during this time cemented its standing as the financial capital of the world. In 1864, the British pound reached an all-time high against the U.S. dollar with an exchange rate of £1=US$9.97.^[5] Although this lofty valuation of the pound was because of both the ascension of the U.K.'s economy and the collapse of the U.S. dollar, it is a good illustration of the magnitude of economic growth realised by the U.K., and how the British pound served as a safe haven for global investors during the Civil War.

{1914-1918} World War I

The late 1800s and early 1900s marked a time of sustained prosperity for the U.K. During this period, the country possessed an enormous geographical empire and boasted the largest industrial economy in the world. The evolution of steam engine technology coupled with an abundance of raw materials supplied by colonies in India, Africa and Australia solidified the U.K.'s position as the premier global economic leader.

Accordingly, the main objective of its leadership was to preserve the status quo and focus upon the management of its vast empire. In order to achieve this goal, political ideals promoted the concept of "splendid isolation."^[10] This essentially meant that the U.K. stayed out of disputes between European countries in favour of directing focus upon its own issues. However, in 1914 this view on foreign policy became obsolete when the U.K. condemned the German invasion of Belgium and entered WWI.

The country's entry into WWI marked the end of the traditional gold standard for the British pound and ushered in a period defined by inflation and currency devaluation. Over the course of this era, the value of the pound dropped 30% against the U.S. dollar, with the exchange rate going from roughly £1 = US$5 to £1=US$3.50.^[11] This loss of value was because of rampant inflation brought on by the financing of war efforts. From 1915-1918, the year-over-year price increase of consumer goods in the U.K. measured 12.5%, 18.1%, 25.2% and 22%.^[4]

Fallout from WWI was felt throughout the 1920s, with the U.K. becoming an economic casualty of the global Great Depression.

{1939-1945} World War II

In contrast to the prosperity experienced in the U.K. during the decades preceding WWI, the economic conditions during the pre-WWII years were bleak. Global depression had stagnated economic growth and the pound suffered a substantial loss of purchasing power. In an attempt to restore value to the currency, the re-institution of the gold standard was spearheaded by Winston Churchill in 1925.

Serving as Chancellor to the Exchequer, Churchill saw a return to the gold standard as the best way to mitigate further damage to the currency. The 1925 enactment of the gold standard in the U.K. lasted until 1931, when it was once again abandoned.^[13] The subsequent devaluation of the pound was sudden, and in 1931 it fell 30% in comparison to the U.S. dollar.

On September 3, 1939, the U.K. once again declared war on Germany, condemning the invasion of Poland and its previous conquests of the Rhineland, Austria and Czechoslovakia.^[15] The impact upon the pound's valuation was immediate. Within the first month after the U.K.'s entry into WWII, the exchange rate of the pound to the U.S. dollar dropped 13% from £1=US$4.61 to £1=US$3.99.^[16] In response to the increased exchange rate volatility, the U.K. government pegged the pound to the dollar in March 1940.

Much like the economic scenario that played out during the WWI era, the British economy suffered inflationary challenges throughout the entirety of WWII. Dramatic increases in the pricing of consumer goods on a year-over-year basis for 1940 and 1941 measured 17.2% and 11.2% respectively. However, as a result of the pound being pegged to the U.S. dollar in 1940, the severity of inflation slowed with measures of 7.5%, 3.7% and 3.1% for the years 1941-44.^[4]

{1944} Bretton Woods

As a result of the desire to pursue global reconstruction and ensure prosperity during the post-WWII era, the U.K. joined the United States and 42 other countries at the 1944 Bretton Woods Summit. The U.K. sent economist John Maynard Keynes as its principal negotiator.

Bretton Woods aspired to accomplish two primary goals: provide a global monetary system which ensured exchange rate stability, and develop a plan for the financing of rebuilding efforts related to the destruction caused by WWII. To achieve these objectives, the International Monetary Fund (IMF) and the World Bank were formed. The IMF and World Bank were commissioned with the tasks of enforcing a set of international exchange rates that were pegged to the dollar, and the management of long-term loans aimed at the restoration of countries destroyed by the war.^[17]

The U.K. entered into the Bretton Woods Agreement in December 1945. In accordance with regulations outlined in Bretton Woods, the U.K. pegged the pound to the dollar at £1=US$4.03. This exchange rate held constant until 1949.^[18]

Initially, agreeing to the terms outlined in Bretton Woods provided stability and effective inflation management for the British pound. It also provided financing needed to ensure the reconstruction of the U.K.

{1949} Dalton Devaluation

In November 1947, Labour Chancellor Hugh Dalton proposed a deflationary budget and currency management strategy for the British pound. Dalton's strategy was an attempt to manage the excessive debts accumulated by the U.K. during reconstruction, and to address convertibility issues facing the pound.

Although Labour Chancellor Dalton was forced to resign shortly after the plan was announced to the public, it was a partial success. The Dalton Plan is credited with creating a positive trade balance in the U.K., turning a 6% deficit in terms of GDP for 1946-47 into a 4.6% surplus in 1949.^[19] However, the plan was not a success in solving convertibility issues. Lack of public confidence in the pound led to a mass exodus into foreign currencies, primarily U.S. dollars. As a result, the Bank of England suspended convertibility.

In 1949, Sir Stafford Cripps, serving as Chancellor of the Exchequer, announced that the fixed rate of £1=US$4.03 was to be adjusted downward 30% to £1=US$2.80.^[20] The devaluation was lauded by the IMF and the United States as a positive step for the U.K., and a healthy move in terms of promoting future international trade. The devaluation became known as the "Dalton Devaluation" and provided exchange rate stability in addition to relatively low rates of inflation until the mid-1960s.

{1967} Pound In Your Pocket Devaluation

The phrase "Pound in your pocket devaluation" is used in reference to the 1967 devaluation of the British pound by Prime Minister Harold Wilson. The name for the monetary policy decision is derived from a famous speech given by Wilson to British citizens. In the speech, Wilson claimed that the subsequent devaluation of the pound wasn't going to negatively impact the value of the "pound in their pocket," but was to stimulate economic growth in the export sector and the economy as a whole.

In reality, the devaluation consisted of an immediate downward adjustment to the pound's value of 14%, from £1=US$2.80 to £1=US$2.40.^[21] The resulting loss of confidence in the pound after the devaluation brought into question its standing as world's second reserve currency.

{1971} End Of Bretton Woods

The 1970s posed severe economic challenges to the U.K., as mounting inflation and debt concerns hindered prosperity. One of the main contributors to the economic hardship was the 1971 dissolution of the Bretton Woods Agreement. Under Bretton Woods, the U.S. dollar was the backbone of the global monetary system. The dollar was backed by gold and was the basis for global exchange rate valuations.

However, the U.S. economy was facing economic strain brought about by widespread foreign capital investiture in the international euro dollar market, and by increased domestic military spending for the war effort in Vietnam. In 1971, the United States realised its first trade deficit since before WWI.^[22] In response to the trade deficit and the presence of other economic challenges, President Richard Nixon decided that the dollar was to be removed from the gold standard. And on August 15, 1971, he announced the decision to the world.

Currencies around the world experienced heightened exchange rate volatility, and the pound was no different. Under guidelines set forth in Bretton Woods, the pound was pegged to the value of the U.S. dollar, which was in turn backed by gold. Without gold as the basis for the valuation of the dollar, the pound became a "free floating" currency.

The value of the pound remained relatively stable in the immediate aftermath of Bretton Woods' end, but inflation rates experienced during the 1970s were indicative of what was transpiring on the global economic stage. For the period of 1974-79, the year-over-year inflation of consumer goods ranged from a low of 8.3% in 1978, to a high of 24.2% in 1975.^[4]

The early 1980s offered no quarter for Britain's economy as runaway inflation posed a major threat to the sustainability of the pound as a viable currency. Inflation rates remained extraordinarily high, with the price of consumer goods soaring 18% in 1980 and 11.9% in 1981.^[4]

Inflation during the 1970s and early 1980s served as a catalyst for volatility facing the pound's valuation. For the period of 1970-85, the pound sustained major fluctuations in value against the U.S. dollar, ranging from a high of £1=US$2.50 in 1971 to a low of £1=US$1.05 in 1985; a range of over 50% of total value.^[24]

{1992} United Kingdom Leaves ERM

In 1990, the U.K. entered the European Exchange Rate Mechanism (ERM). The ERM was to be the precursor to the euro, and it allowed the foreign exchange rates of member nations' currencies to freely "float" against one another within specified limits. The goal of the ERM was to provide exchange rate stability for member nations and provide the groundwork for a future unified currency.

The U.K.'s exit from the ERM came abruptly on September 16, 1992. Nicknamed "Black Wednesday," the widespread selling of the pound by speculators caused a drop in value against the German deutsche mark, the currency in which the pound was pegged to under the ERM guidelines. To remain in the ERM, the U.K. was charged with the task of keeping the pound's value within 6% of the original exchange rate of £1=DM2.95.

On "Black Wednesday," the Bank of England and U.K. Chancellor Norman Lamont took extensive measures to keep the pound's value within the guidelines set forth by the ERM. The Bank of England spent £3.4 billion in an attempt to prop up the pound, while Chancellor Lamont raised interest rates from 10% to 12% and eventually to 15%.^[26] The aggressive moves to protect the pound failed, and on the evening of September 16, 1992, Britain withdrew from the ERM.

The short-term fallout from that withdrawal was substantial. Over the following few weeks, the pound fell 15% against the deutsche mark, and it was estimated that the U.K. treasury suffered losses eclipsing £3 billion.

{2008} Financial Crisis Of 2008

The global financial crisis of 2008 served as a reminder that steady economic growth and low inflation can still place national economies at risk of catastrophe. Although the causes for the crisis are debatable, several lending and investment practices bear the brunt of scrutiny related to the meltdown.

The U.S. housing market is one of the most commonly cited causes of the financial crisis. "Subprime" mortgage lending practices and the creation of collateralised debt obligations (CDOs) are aspects of the mortgage-lending industry blamed for the meltdown. Other causes popularly believed responsible for the crisis are reckless capital investment practices employed by large banking institutions, universally poor regulation of the financial industry, and depressed international interest rates partially brought on by vast amounts of saved capital in Asia.

No matter the primary cause, the result was the largest economic downturn since the Great Depression. In all, the market volatility created during the first nine and a half months of 2008 dissolved 45% of the total value of global equities.^[28] As a consequence, bank failures became commonplace, with the largest being the Lehman Brothers bankruptcy in September 2008.

The collapse of the banking sector in the U.K. was monumental. Beginning in April 2007, nine of the country's largest publicly traded banks were listed on the FTSE 100 Index and boasted a market capitalisation of £316.9 billion. In April 2009, only seven U.K. banks were listed on the FTSE 100, having a market cap of £138.1 billion.^[29]

In concert with the drawdown in equities and subsequent banking collapse, the pound experienced heightened volatility during the period surrounding the 2008 crisis. The currency hit a 26-year high against the dollar in November 2007 with a value of £1=US$2.12. As the global economic crisis deepened, the pound reflected the troubles in equities and the banking industry. And in January 2009, the pound hit a 24-year low against the U.S. dollar at £1=US$1.35.^[30]

In addition to the losses against the dollar, the pound weakened against its counterpart the euro and hit an all-time low in December of 2008 at £1.06=€1.^[30]

{2016} Brexit Vote

Membership in the European Union (EU) has been a controversial topic of discussion in the U.K. for many years. A potential settlement to the debate came on June 23, 2016 with the outcome of the "Brexit" vote.

Britain's affiliation with the present-day EU began with its joining of the European Community (EC) in 1973. From then to the present, the U.K. has operated as a member of the EU, but has remained independent in terms of its national currency. Aside from a two-year foray into the ERM from 1990-92, monetary interests in the U.K. have remained exclusive from those of other EU countries. The U.K. has resisted the shift towards implementing the euro as its national currency in favour of the preservation of the pound.^[31]

The term "Brexit" is a combination of the words "Britain" and "exit," and serves as a self-explanatory acronym for the vote on whether or not the U.K. was to remain a member of the EU or leave it. The voter turnout for the Brexit referendum was large. More than 30 million people, 71.8% of all U.K. citizens, cast votes designated as either "stay" or "leave." The final result was tallied 52% to 48% in favour of the U.K. to "leave" the EU.^[32]

The immediate effect of the Brexit vote on the pound was devastating. During the overnight trading session as the Brexit votes were being counted, the pound challenged lows established in 1985 versus the dollar at £1=US$1.32. By the end of the London trading session on June 24, the pound plummeted almost 9% against the dollar, representing one of the largest single-session sell-offs on record.^[33] In an attempt to provide stability, the Bank of England pledged a sum of £250 billion to be used in efforts to preserve the value of the pound.

Global equities markets spun into chaos as the result of the Brexit vote were digested by market participants. On June 24, 2016, equities market indices worldwide suffered dramatic drawdowns. In the U.S., the S&P 500 registered a decline of 3.59%, while in Britain the FTSE 100 sold off 3.15%. German equities fared no better, with the DAX Index realising a loss of 6.82%.^[34]

The long-term ramifications of the U.K. leaving the EU are largely unknown. Brexit supporters cite the potential for economic growth and the appreciation of the pound as probable through a reduction of government spending and the establishment of trade alliances independent of EU regulation. However, opponents of leaving the EU claim that economic growth is likely to suffer due to a shrinking export sector and lower rates of new foreign capital investment. Ultimately, time will tell if the decision to leave the EU is one that fosters future prosperity for the U.K.

{2016-2020} Brexit Transition

While the U.K.'s vote for Brexit was a succinct matter, the actual transition period was anything but that. The subsequent four years were filled with legal challenges, negotiations and a change in Great Britain's prime ministership. Throughout the Brexit transition, the pound sterling exhibited periodic volatility in response to the events of the day.

Challenging Article 50

According to EU law, triggering Article 50 of the Lisbon Treaty was the first step in any member nation leaving the union. In November of 2016, a legal challenge was brought to stop the initiation of Article 50 by two citizens of the U.K. The motion sought an official Parliamentary vote to approve or deny the enacting of Article 50.^[35] Eventually, the motion was successful and brought about a formal March 2017 vote.

From the legal challenge put forth in November 2016 to Parliament's vote in March 2017, fresh uncertainty was interjected into the Brexit process. During this period, the GBP showed strength as currency traders priced-in the possibility that the U.K. would not exit the EU after all. In total, the GBP/USD rose by 3.04% and the GBP/EUR 4.9% followed suit.^[36]

In March 2017, Parliament passed the "Article 50 bill" and cleared the path for Prime Minister Theresa May to officially invoke Article 50 of the Lisbon Treaty in late-March 2017. Upon May doing so, the GBP showed short-term weakness against the majors as Brexit chaos once again plagued valuations.

Brexit Day Is Postponed

Following May invoking Article 50, U.K. and EU negotiators had two years to iron out the final details of Brexit. Several key issues hampered progress, including U.K. fisheries, immigration and the status of the Ireland-Northern Ireland border. These issues, among others, prompted heated debate regarding whether the U.K. was to leave with or without a final divorce deal.

The controversy reached new heights in early-2019, with a vote of "no confidence" tabled by the Labour party against the sitting government. Although PM May survived the vote by a slight margin, no EU/U.K. divorce deal gained Parliamentary approval. Subsequently, Brexit Day was delayed from 29 March 2019 to 31 October 2019.

Following this postponement, the GBP entered a period of relative weakness versus the majors. From 1 April 2019 to 1 October 2019, the GBP/USD (-7.5%), GBP/EUR (-2.9%) and GBP/CHF (-5.3%) all surrendered market share.^[36] The primary reason for the GBP's slide was the political uncertainty prompted by May stepping down as PM in June 2019 and the subsequent election.

Boris Johnson Becomes Prime Minister

Following a month-long campaign tour, conservative party members held a vote for the new Prime Minister of U.K. in July 2019. There were two main candidates, Jeremy Hunt and Boris Johnson. The latter won, posting a nearly 2/1 margin among a turnout of more than 130,000 Tory party participants.^[37]

An outspoken Brexiteer, Johnson led the U.K. throughout the remainder of the transition period. Withstanding an unprecedented suspension of Parliament and December 2019 snap General Election, Johnson navigated turbulent political waters during the final stages of Brexit. On 31 January 2020, the U.K. officially left the EU.

The period from the October 31 2019 divorce date until the 31 January 2020 Brexit Day was tumultuous for the GBP. Values of the GBP/USD (+2.4%) and GBP/EUR (+2.6%) experienced whipsaw volatility, but finished in the pound sterling's favour.^[36] Ultimately, the end of the Brexit transition proved beneficial to GBP holders.

{2020-Present} The COVID-19 Pandemic

One of the most impactful events in financial history was the emergence of the novel coronavirus pandemic. Labelled COVID-19, the virus roiled capital markets from its opening stages in March 2020 throughout the calendar year.

Regardless of asset class or market, enhanced periodic volatilities became commonplace during the initial COVID year of 2020. The pound sterling wasn't spared. Forex traders aggressively priced the impacts of pandemic fallout and the adoption of unlimited quantitative easing (QE) by the world's central banks.

Initial Stages Of COVID-19

Late February and early March 2020 saw COVID-19 evolve into a global pandemic. Faced with a rapidly spreading contagion, global governments responded by instituting lockdowns, travel bans and mass quarantines. The result was extreme market turbulence in shares, commodities and currencies.

On the forex market, the USD swiftly became the premier global safe-haven asset. Through the first three weeks of March 2020 (2-20 March), the GBP/USD plunged by 8.8%, while the GBP/EUR fell by 6.6%.^[36] On both sides of the Atlantic, the pound sterling exhibited weakness as forex participants favoured the euro and U.S. dollar.

Unlimited QE

In response to the onset of COVID-19, central banks around the globe crafted exceedingly dovish monetary policies. During March 2020, the Bank of England (BoE), European Central Bank (ECB), Bank of Japan (BoJ) and United States Federal Reserve (Fed) all cut interest rates and expanded open market operations. The Fed led the charge in this department, implementing its unprecedented policy of "unlimited QE."

Fed Chair Jerome Powell announced unlimited QE on 23 March 2020. In a press conference, he pledged that the Fed would execute unlimited asset purchases to complement the previously instituted 0.0-0.25% Federal Funds Rate.^[38] The announcement came on the heels of BoE head Andrew Bailey suggesting that the U.K. central bank was willing to inject unlimited quantities of capital into the economy to mitigate the financial damage of COVID-19.^[39]

As both the U.K. and U.S. adopted unlimited QE, the pound sterling reversed course against the euro and dollar. From 1 April 2020 to 31 December 2020, the perceived impacts of global quantitative easing brought many forex traders and investors back around to the GBP. During this period, the GBP/USD (+10.1%), GBP/EUR (-0.6%) and GBP/CHF (+1.4%) traded mixed as the pound largely increased its value vs the majors.^[36]

Summary

As history has evolved, the GBP has exhibited sensitivities to a vast array of world events. From the Napoleonic wars to COVID-19, adopted governmental and central banking policies have significantly impacted the pound sterling's value. Due to these historical examples, forex participants are well advised to stay on top of breaking news items and current market underpinnings when trading the GBP.