In this post I want to answer the question: does the Bank of England set foreign exchange rates? This might be of interest if you need to change currencies, but want to know how and when to get the best exchange rates.
In one word: no, the Bank of England doesn’t set foreign exchange rates. Instead, the Bank of England sets interest rates, which might be what you’re confusing this with. Interest rates determine how much interest savers get in their bank accounts. So for instance, if interest rates are high, people get a higher monthly return on the funds they keep in the bank.
Influences Foreign Exchange rates?
However, just because the Bank of England doesn’t set foreign exchange rates, it nonetheless has a strong influence on them. This is exactly because it controls interest rates. In short, it works like this:
1. If interest rates are high, then investments in the UK tend to deliver a better return. This is exactly the same as when you decide to save money in a bank account.
2. Higher returns therefore make UK investments more attractive to international markets.
3. To take advantage of these opportunities, investors therefore purchase UK pounds (you can only invest in the currency of the country you’re focused on.)
4. Because the pound is more in demand then, its value increases, making it more expensive in foreign exchange.
In this way, the Bank of England can have a big influence on foreign exchange rates, by controlling to some extent how attractive UK investments are. If the central bank raises interest rates, investments seem more worthwhile, and the pound goes up. If the BoE cuts interest rates, then the opposite happens.
Foreign Exchange Influence Today?
So what’s happening at the moment? Well, in the last five years or so, the pound has lost a huge amount of ground, against the euro in particular, as the Bank of England has cut interest rates to their lowest ever levels. The reason the BoE has done this is to encourage exports: if the UK pound is weak, international companies can purchase more British goods for less, therefore stimulating growth. This is part of a government plan to rebalance the economy away from domestic consumption.
Furthermore, given that this scheme is really only now gathering steam, it looks as though interest rates (and hence UK pound exchange rates) will remain low for the foreseeable future. The Bank of England will not raise interest rates until the UK economy is on firmer ground again.