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Why has the pound fallen? What can be done about it and what it means for you

The pound hit a record low on Monday. Photo: Dominic Lipinski/PA
The pound hit a record low on Monday. Photo: Dominic Lipinski/PA

The British pound sterling had its worst day on on record after Kwasi Kwarteng's tax cutting bonanza caused concern amongst economists and investors.

Falling by at least 4.7%, it dropped to its lowest level since decimalisation in 1971, when pence and shillings were shelved.

"Sterling looks like an emerging market currency, especially when you look at the price of the British Pound a few months ago and compare it to where it is now," Naeem Aslam, chief market analyst at Avatrade said.

But why has the pound gone into decline, and what does that mean for you and the economy?

Read more: Pound crashes to all-time low against dollar as Kwarteng signals more tax cuts

Why is the pound falling?

On Friday Kwarteng sent the currency dwindling, falling to a 37-year low soon after his first fiscal announcement since becoming chancellor.

However, that was just the start. Sterling broke all record in the early hours of Monday, falling to an all-time low against the dollar to $1.0327 before regaining some ground to $1.05.

The run followed additional comments from Kwarteng over the weekend, which have incited concerns about additional debt-filled tax cuts after he hinted there were "more to come".

Investors and economists worried that the government’s plans to ramp up borrowing comes at a time when interest rates are rising, meaning debt will not only pile higher but also become more expensive to service.

The mini-budget puts government borrowing as a share of gross domestic product on track to hit 92.4% in five years, Capital Economics estimates, trashing the fiscal plans put in place by Boris Johnson's administration that stated debt levels should fall within three years.

Kwarteng’s promise for more tax cuts suggests he will not bow to market pressure, even promising to set out a medium-term fiscal plan on 23 November to convince investors that debt will fall.

Investors already worried about the state of the government’s finances and the money needed to fund the fiscal plans, have been further alarmed by Kwarteng and prime minister Liz Truss's goal to reach their target of 2.5% annual growth.

Read more: Mini-budget: 'Trussonomics' baffles investors as bonds and pound tank

What can be done about it?

Analysts have called on the Bank of England to intervene and raise interest rates to stave off a further decline and potentially prevent the pound hitting parity with the dollar – or worse falling below parity.

An emergency rate rise could help prop up stering and prevent market panic spiralling out of control.

But it also risks giving a sense of panic. Governor Andrew Bailey and the Monetary Policy Committee have already lifted rates to a post-financial crisis high of 2.25% last week to tackle the highest inflation for 40 year.

On Monday evening the BoE ruled out an emergency meeting but Bailey said in a statement: "The MPC will not hesitate to change interest rates by as much as needed to return inflation to the 2% target sustainably in the medium term, in line with its remit."

Watch: Pound plunges as UK fiscal plan rattles markets

Inflation

UK inflation could push higher with analysts warning the pound’s plunge towards parity with the dollar could send the cost of goods soaring even more, potentially worsening the cost of living crisis.

Samuel Tombs, an expert at Pantheon Economics, on Thursday said that inflation is likely to rise by around 0.5% in 2024 because of the recent falls in sterling.

This means that every £1,000 that a family spends will be worth £5 less simply because of the drop in the pound, and it will leave the average household about £150 worse off every year — adding to runaway inflation, currently at 9.9%.

Food prices

Products imported into the UK, such as those used by the food and drink sector, could become more expensive, potentially leading to price increases being passed on to customers.

Experts at Kantar said grocery inflation increased by 12.4% in August as the food and drink industry had already come under pressure from energy cost increases.

Paul Davies, chief executive officer of the Carlsberg Marston’s Brewing Company, said the pound’s slide to a record low was "worrying" for the beer sector, which imports beer and hops.

A driver fills a car with fuel at a petrol station in London
Falling pound means higher petrol prices. Photo: Frank Augstein/AP

Energy and petrol costs

Energy bills and fuel costs are likely to rise when the pound falls as the price of the gas that is used in Britain is based on the dollar — even if it is produced in the UK.

Watch: How does inflation affect interest rates?

Travel

Going on holiday will become more expensive, especially when visiting the US and other countries whose currencies the pound has dropped against.

Holidaymakers concerned about the fall in the value of the pound have been urged to "watch rate movements carefully".

Nick Boden, head of foreign currency provider Post Office Travel Money, warned that "sterling’s volatility makes it impossible to predict how exchange rates will behave in the coming weeks".

Purchasing $500 cost around £480 at some points during the day, compared with approximately £440 on the same day last week.

"Our advice for people planning overseas trips is to watch rate movements carefully in the weeks leading up to their departure, and change money at times when the rate rises." Boden said.

Airlines also face increased bills for buying fuel and leasing aircraft. Carriers pay for a large proportion of their costs in US dollars, such as fuel, which could push up flight ticket prices.

EasyJet (EZJ.L) chief executive Johan Lundgren admitted that the fall in the value of the pound "does have an impact" on its finances.

"Clearly, the dollar is very strong versus the pound," he said speaking at the carrier’s headquarters at Luton Airport. "It has an effect. We have a lot of expenses in dollars and we have revenues coming in in pounds."

However, with the euro dropping to a 20-year low, holidays to the continent are unlikely to increase much in price because of currency changes, meaning its cheaper for tourists to come to the UK.

Read more: Kwasi Kwarteng announces biggest tax cuts since 1972 in UK growth push

What it means for personal finance

While higher interest rates tend to attract savings deposits to the UK and in turn increase the value of the pound, the cost of borrowing for households and businesses could go up.

Experts have warned that savers are "likely to lose more of the value of their savings".

"Because the falling pound is likely to push inflation higher, it means savers are likely to lose more of the value of their savings once inflation is taken into account," Sarah Coles, senior personal finance analyst at Hargreaves Lansdown said. "If you leave your money languishing in a high street easy access account paying less than half a percent, runaway inflation will very quickly consume the spending power of your cash."

Watch: Why are gas prices rising?

What it means for private investors

Although the impact of sterling’s crash depends on the type of assets investors hold, typically the FTSE 100 (^FTSE) tends to benefit from a weaker pound.

That is because most big firms listed on London’s bluechip index actually earn most of their money overseas, which will be worth more when it’s converted back into pounds.

But businesses that make their money in the UK will face challenges.

Coles added: "Retailers and other businesses who buy goods in from overseas face rising costs.

"They can try to pass the higher cost of imported goods on to consumers, or they can try to cut their operating costs, but the speed with which sterling has fallen is going to make life horribly difficult.

"That's why the more domestically-focused FTSE 250 (^FTMC) is likely to be more sensitive to the weaker pound."

Read more: Bank of England rules out emergency interest rates meeting

Bonds and gilts

The chancellor's debt-fuelled mini-budget on Friday sent sterling and UK bonds into meltdown – but matters only got worse on Monday.

Britain has suddenly become a riskier bet, and traders have dumped UK assets in the wake of the statement, selling off the pound and sending government borrowing costs surging.

The price of UK five-year government bonds is now below both Italy and Greece, a decade after the eurozone debt crisis was gripping markets. Yields rise when bond prices fall.