Tuesday, June 1, 2010

Run on the Pound

A run on the pound refers to a situation where international investors become nervous over holding sterling and sterling assets, and so sell as quickly as possible.

A run on the pound may occur when markets feel the Pound is overvalued and likely to fall quickly. If markets expect the pound to fall, they will sell quickly before making a loss.

What May Cause a Run on the Pound?

  • A run on the pound is more likely in a semi fixed exchange rate. e.g. when the Government is committed to trying to keep the Pound at a certain level. If markets feel this level is unsustainable they may keep selling Pounds until the government is forced to devalue.
  • For example, in 1992, the UK tried to maintain value of Sterling in ERM, but, ultimately markets forced the UK out and we had to devalue. We also had a run on the pound in the late 60s, causing the Wilson government to devalue pound. (In 1967, Wilson devalued pound by 15% after selling many foreign currency reserves trying to maintain value of Pound)
  • In 1976 there was another on the Pound as markets feared the UK's fiscal position.
  • High Inflation - high inflation reduces the value of Pound Sterling. Foreign investors will be nervous of holding UK assets if the UK has high inflation
  • Threat of Sovereign Debt Default. If markets feel government borrowing is too high and unsustainable then there is a risk of foreigners losing their government bonds. Therefore, the market will sell bonds causing an outflow of foreign currency and fall in value of sterling. This can build up a momentum effect. As the fall in the currency can alarm other investors.

Is the UK at risk from a Run on the Pound?

At the moment, we aren't. Firstly the Pound is floating i.e. governments are not trying to keep its value high. The Pound has already depreciated by about 20% in past 18 months. - This wouldn't count as a run on the pound but large gradual depreciation. With a floating exchange rate, there is less chance of markets feeling an exchange rate is fundamentally overvalued.

UK's debt is a concern, but, we still retain AAA rating and prospects for growth have improved situation. It certainly looks worse in some other European countries

Would Membership of Euro protect against A Run on the Pound?

Well, we couldn't have a run on the Pound, but, it doesn't solve the underlying problems like lack of competitiveness, excessive government borrowing, negative growth. Being outside the Euro, would give Greece more flexibility for dealing with their crisis.


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