The pound has plummeted to its lowest level in more than three decades against the dollar in the wake of the Brexit vote.
Here’s why it happened and whether households and businesses should be braced for further falls.
Why has the pound fallen?
The value of the pound is influenced by a number of factors, including growth, interest rates and inflation.
Strong economies have strong currencies because investors want to put their cash into countries where growth prospects are strong.
They need local currency to do this, and the increase in demand for sterling pushes up its value.
That’s why when there’s good economic news, such as robust GDP figures or strong jobs growth, the value of the pound rises.
Investors believe Britain’s decision to leave the EU has reduced the country’s growth prospects. This has triggered a sell-off in sterling.
In the coming weeks and months, foreign investors may also become more nervous about buying and holding UK assets.
The UK is reliant on foreign money – around £100bn a year to be exact – to finance its huge current account deficit, which measures the difference between money flowing in and out of the country. The pound is vulnerable to further falls if investors suddenly pull their cash out of the UK.
Central bank interest rates also matter: higher rates attract overseas capital looking for better returns.
At the start of this year, financial markets believed that the UK would raise interest rates this August. This helped to lift the value of the pound against a basket of other currencies.
The Brexit vote means traders are predicting lower growth – and interest rates – for much longer. The result? Markets have fully priced in a rate cut by the end of this year.
Rates aren’t expected to rise again until November… November 2020, that is.
What does it mean for households and businesses?
For Britons planning their summer holidays, it’s bad news. A weaker pound means consumers will get less bang for their buck overseas.
A family changing £1,000 into dollars would have received up to $1,501 last week. Today, £1,000 buys just $1,318.
A weaker pound also means UK businesses have to pay more for goods they buy in foreign currencies, making imports more expensive. These higher costs could fuel domestic inflation.
Economists at HSBC believe consumer inflation will jump to 4pc next year – which is double the Bank of England’s 2pc target.
A weaker pound is also likely to push up petrol prices because oil is traded in dollars and Britain is a net importer.
Last week, the AA said prices were likely to rise by around £1.25 a tank if sterling remained around the current level “over the next 10 to 14 days”.
If the pound falls further, prices at the pumps are likely to rise even more.
For exporters, the news is brighter. A weaker pound makes their goods more competitive, boosting growth.
Manufacturers have complained in recent years that the strong pound has hurt trade. The weakness in the run-up to the vote has helped British factories to weather uncertainty.
However, Britain doesn’t sell as many things overseas as it once did.
The massive depreciation of sterling seen in the wake of the financial crisis did not eliminate Britain’s trade deficit.
A weaker pound may also boost the economy through tourism, as travellers flock to Britain to spend their dollars and euros.
How will policymakers react?
Everything is relative.
Mark Carney, the Governor of the Bank of England, attempted to calm markets on Friday, insisting that policymakers “will not hesitate” to act if needed.
The Bank is ready to flood the markets with cash on Tuesday via an auction of long-term loans to prevent investor panic. The auction is the last of three special operations conducted around the referendum.
Banks snapped up £2.46bn in extra liquidity in the first auction. The second, held just two days before the vote, saw demand fall to £370m. It is likely to be higher this time.
Maintaining financial stability is key. The Bank’s Financial Stability report on July 5 will offer the first insight into the thinking on Threadneedle Street.
Most economists also expect the Bank to cut interest rates in the coming months.
This could weaken the pound further, and potentially stoke inflation, but may be needed to boost flagging growth.
“In the coming weeks, the Bank will assess economic conditions and will consider any additional policy responses,” said Mr Carney.
In any case, policymakers will be watching closely to see if a weaker pound feeds into weaker sentiment and spending decisions.