Living in the UK, you’d be forgiven for feeling woeful about the country’s economy. Soaring inflation, which reached 10.4% in February, has pushed the prices of ordinary items like fresh food up at the fastest rate in 45 years. (If you can find even these food items, that is; shortages have left supermarket shelves bare of several products, with fresh produce affected by poor harvests and energy prices.) Homeowners’ mortgage payments have shot up, and the country is only just emerging from a winter of astronomical energy bills, which the government was forced to to subsidize.
But there have been some mildly bright spots, even if ordinary Britons don’t necessarily feel their effects everyday. The UK economy managed to avoid dipping into recession in the last quarter, although only just. And the pound, which crashed against the dollar in late September 2022, has regained much of its strength.
Why has the pound recovered against the dollar?
From a particularly low dip last September-October, concurrent with Liz Truss’s disastrous and short-lived prime ministership, the pound has soared to a ten-month high. The dip last fall was triggered by Truss’s disastrous “mini-budget,” which proposed a package of tax cuts and borrowing. These measures freaked out financial markets so badly that the mini-budget was summarily cancelled, and Truss resigned. The sliding pound even brought American homebuyers to the UK, eager to snap up bargains with their strong dollars.
One of the main factors driving the pound’s resurgence is that the economy is now in different hands. Secondly, natural gas prices, which spiked dramatically after Russia’s invasion of Ukraine, have fallen back to pre-war levels much quicker than expected. Finally, the UK had been expected to enter a recession but narrowly avoided it in the last quarter. The economy is not performing well—but it’s not as bad as expected.
On the US side of the equation, the dollar has also lost some ground against other currencies, including the pound.
The US was on the right side of the natural gas trade, because it has plenty of locally produced gas and other energy, explained Jonas Goltermann, a senior economist at Capital Economics, a London-based research firm. So when prices corrected, the dollar lost some of that boost. The Federal Reserve, which uses interest rate hikes to control inflation, has also been less aggressive than some might have expected, he said. A slower pace of hikes has had the effect of weakening the dollar. Thirdly, the March 2023 collapse of a brace of banks and other related frailties in the banking sector have dented international confidence in the US’s economy.
“One way to think of currencies is that it’s like a marathon that never really ends,” said Goltermann. Last year, the dollar was strong because the US economy was outperforming others, “leaving everyone in the dust.” With the advent of the recent banking problems, he said, “it’s a bit like they’re far out in the distance, but they’re starting to limp.”
The pound’s strength relative to the dollar is only one part of a complex picture, of course. Most of the UK’s imports come from Europe, and that’s where people tend to go on holiday, Goltermann pointed out. So the pound’s value compared to the Euro, which has been fairly flat in recent months, will probably have a bigger real impact on people’s lives.