More than likely that the largest single factor that will affect demand for the pound is the economic health of the United Kingdom or how the market is expecting the United Kingdom economy to fare in the future.
Sterling is what is known as a free floating currency, so its exchange rate or its price in relation to another currency is determined purely by supply and demand. Simply put, the more the pound is in demand internationally then the stronger its exchange rate will become.
Investors are apt to move money away from weakening economies. The worsening of expectations for the economy in the UK during 2010 goes a long way to explain sterling’s sharp decline.
Looking at exchange rates and its affect by the strength of the pound. A higher interest rate will mean you will be able to get a far better return on bonds and other Government securities and therefore this in turn will tend to attract financial capital from abroad. If currency markets expect the United Kingdom base rate to fall, the pound as a knock on effect will tend to weaken.
According to Winchester Electronics, a UK based company who specialise in rack and panel connectors, a currency is likely to weaken in order to correct a big trade deficit, which is unsustainable in the long-run, therefore making exports cheaper and imports a lot more expensive.
One of the effects for most families is an increase in the cost of travelling abroad. As a pound buys less of a foreign currency, hotels abroad, goods and services will become much costlier.
This also means that imported goods to the United Kingdom in turn will become more expensive to consumers and to businesses that import raw materials or components as part of their production process. Meanwhile exporters who price their goods in sterling will benefit as their goods will become cheaper in overseas market.
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Hassam 