Readers Question: You say that the UK government is borrowing rather than printing money. Is it borrowing this money from overseas reserves? If so then how does this affect the exchange rate?
UK government borrowing is financed by borrowing from the private sector. Government debt is financed by selling gilts, securities and bonds. Mostly the UK debt is bought by UK private sector groups. (e.g. pension funds, investment trusts, private investors)
However, a certain % of government securities are bought by foreign investors. I'm not sure of the %, but I remember hearing a figure of 25% of UK government debt is held by foreign investors.
If foreigners are buying UK government debt then it increases demand for sterling. If foreign investors became nervous of holding UK government debt (e.g. because of risk of debt default) then the Pound would fall as foreign investors sold their UK securities