Exchange rates

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If you go on holiday abroad you would have to change your pounds into the currency that is used in the country you are visiting, in America you would need dollars and in Spain you would need Euros. The exchange rate tells you how much of another currency you will get for £1, for example £1 = $1.50 (one pound equals one dollar fifty cents) and £1 = €1.55 (one pound equals one euro fifty-five cents).

Exchange rates are important for businesses that buy and sell their goods and services abroad:

Imports occur when UK companies buy goods and services from abroad;
Exports occur when UK companies sell goods and services to other countries.

Exports and imports are split up into visibles and invisibles:

Visibles are goods that we can touch and see, for example cars, bananas and computers;
Invisibles are services that can not be touched or seen, for example finance, transport and insurance.

Exchange rates are always changing and this can have a big impact on businesses that import and export. If we imagine the exchange rate with American dollars is £1 = $1.50, then a business who sells their product in the UK for £10 will be able to sell it in America for $15 (£10 × $1.50).

If the pound becomes stronger and the exchange rate rises to £1 = $2, the same business who still sells their product for £10 in the UK will now have to charge $20 in America (£10 × $2). This will be mean that they will sell fewer goods abroad because the price has gone up in other countries even though the price remains the same in the UK.

We can therefore say that a strong pound is bad for UK exporters. If the pound got weaker the opposite would occur, in other words the price in other countries would go down and the UK business would export more. This means that a weak pound is good for British exporters.

It is a different story for businesses that import goods and services. If we use the same scenario as before where the exchange rate with American dollars is £1 = $1.50, then an American business who sells their product in the USA for $15 will be able to sell it to a UK business for £10 ($15 ÷ $1.50).

If the pound becomes stronger and the exchange rate rises to £1 = $2, the same business who still sell their product for $15 in the USA will now only have to charge the UK business £7.50 ($15 ÷ $2). This will be mean that the British business’s costs will go down because they are paying less for the goods even though the price remains the same in America.

We can therefore say that a strong pound is good for UK importers. If the pound got weaker the opposite would occur, in other words the price American businesses would have to charge would go up and the costs of British businesses would also go up. This means that a weak pound is bad for British importers.

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