The Bank Of England Effect
Posted by Allison on 20 April 2009, 11:28
The Bank of England does a lot more than simply print money. And at the moment it has been in the spotlight rather more than it normally would be too. Thanks to the effects of the recession and the banking crisis that has beset the country (and indeed many other countries elsewhere too) the Bank of England has rarely been out of the headlines recently.
One of the most important things that it does is to set interest rates. At present those rates are set at just half a percent. They have never been this low before and they don’t look set to rise for a while either. You can read the official news release about this latest development on the Bank of England website itself, at this link.
But what is perhaps more interesting is the fact that whatever news comes out of the Bank of England, it can have an effect on the exchange rate between the pound and other currencies. Now it does happen sometimes – as happened this time – that commentators will know what the Bank is going to announce, i.e. whether there is going to be a rate cut or not.
So when the announcement is made there is no change to the strength of the pound on the currency markets. This means if you are looking at figures on your currency converter they won’t change very much before or after the announcement is made.
But sometimes it happens that the Bank of England will surprise people. A short while ago the Bank made a move that we weren’t expecting. Back in December 2008, as the recession really got a grip on the country as a whole, the Bank decided it would reduce the bank rate from 2% (as it was at the time) to 1%. Many people expected a 0.5% cut, but one of twice that size came as something of a surprise.
Now let us take a look at what happened to the British pound against the US dollar at that time. On the 1st December the exchange rate was 1.4981. The pound actually did better the next day and claimed 1.4991 dollars to the pound.
After that – and on the eve of the announcement by the Bank – the rate fell to 1.4768. And by the time the rate cut had hit the headlines the pound finished the 4th December on 1.4630. It dropped a little further too the next day to finish on 1.4614 for the week.
So you can see the effect a surprise piece of news like this can have on the pound. The Bank must surely have to brace itself against the pound losing further ground simply because of a statement it makes. After all the powers that be in the Bank know that a rate cut is sometimes the best move they can make, even if it does harm the pound temporarily.
It does show how complex things can be though. We may not think that a few simple words can have such an effect on the pound, but it has been shown that they do. On the 9th April the Bank announced the rate would stay as it was for now, and the pound dropped very slightly against the dollar, from 1.4711 to 1.4676 at the end of that day.
What will happen when the next announcement is due, we wonder?